Tech downdraft may spread: James Saft

April 15, 2014

By James Saft

(Reuters) – Calling the stock market downdraft a correction contained to technology may be both optimistic and premature.

With Federal Reserve aid to the stock market ebbing, and margin debt at all-time highs, what started with the most expensive stocks could easily do much damage to more conservative investments.

Last week was the worst for the tech-heavy Nasdaq index since June 2012, and though all major U.S. indices finished the week lower the most striking losses were among shares which had enjoyed very strong upward momentum. Twitter is down more than 40 percent from its high this year, while Netflix is off 27 percent and Facebook nearly 20 percent. Overall social media stocks, which rose 65 percent last year, are down 15 percent so far this year.

There is a temptation when tall poppies are cut down for those of us with more exposure to the real rather than virtual economy to try to reason that the scythe will not bother with us.

In this case there are some reasons to worry.

It is probably not a coincidence that the flagging of the stock market, which is slightly down this year after surging since quantitative easing began, has happened at the same time as the Fed commenced its plan to taper bond buying.

Bond buying was a boost to financial markets, but one whose benefits were disproportionately felt by riskier instruments. Riskier stocks did better than safer ones, by and large, and social media and biotechnology companies are among the riskiest.

While the unwinding of that benefit quite naturally will be felt first and hardest by those companies with the most stretched valuations, QE was, in practice, a policy which encouraged risk taking of all sorts. So while you might expect the shares of companies which sell the necessities of life to do better than technology high flyers as QE unwinds, the overall pressure felt by stocks, which are inherently riskier than bonds, will be downward.

That was exactly the case in 2000 and 2007; and though stock market valuations now are not as intensely crazy as they were in 2000 or the economy as blithely oblivious to the dangers of debt as it was in 2007, that does not mean that this time the broader market will be spared.


One thing which arguably is flashing as red a sign as it ever has is margin debt – money borrowed to buy securities. Margin debt hit an all-time high in February, according to the most recent reading from the New York Stock Exchange, up 27 percent from the year before and nearly 70 percent over two years.

While some margin borrowing can be used to bet against stock gains, the overall historical trend is for margin borrowing to trace the lines of exuberance in the stock market. Margin debt peaked, at lower levels, just before the tumble of 2000 and just after things began to get hairy in 2007.

Again, the likelihood is that margin buying is concentrated among shares in those companies which have soared highest, fastest. If margin debt begins to decline, as indeed the data may show it already has once it is released, those momentum shares will fare worst.

But this will likely be a difference in degree rather than direction. Margin borrowers don’t only sell the shares they have borrowed to buy when under pressure, but also those shares they own which have held more of their value.

Hedge funds too are borrowing more money to invest, raising the potential for sharp market moves. Hedge funds’ weighted average ratio of gross assets to capital recently hit 1.70, just above the previous peak hit in, you guessed it, 2007.

None of this is by any means foreordained. New peaks in leverage and debt can continue to be made for quite some time, and economic growth could prove to be surprisingly strong now that the snows of winter have melted. In other words, stocks could continue to go up for valid or invalid reasons.

If anything the chief difference between today and 2007 or 2000 is not the story behind the technology or the mania for property. It is instead that we all know that, to some unquantifiable extent, the rally of the past several years has been engineered by official policy.

While bubbles like those in dotcom and property pop, official policy tapers, and does so with lots of fair warning.

That argues for continued pressure downward in stocks, which will be felt across the market. Not a rout but a taper.

(James Saft is a Reuters columnist. The opinions expressed are his own)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at and find more columns at

(Editing by James Dalgleish)

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