So with that being said, let’s just hop right into the video alright. So this article right here from yahoo finance, says hedge fund blow up, sends shockwaves through wall street and the city further down in this article. It also says a little known hedge fund that blew up last week has sent shockwaves through the world of investment, banking shares of credit, suisse and numera sunk over 10 on monday. After both warned, they face potentially billions in losses linked to a hedge fund, archagos capital banks that worked with archagos and lent it money to buy shares were scrambling to offload archagos investments after a handful of risky bets made by the hedge fund went bad. The rush to exit these positions hit public shares prices, leaving banks with huge losses. Hedge funds typically borrow money from banks to invest a process known as margin trading. This allows hedge funds to leverage up the cash they hold and increase their positions potentially earning far greater returns if their bets come good. However, it also means that hedge funds can theoretically lose more money than they hold in client funds. If trades made on margin turn sour banks will ask a client to put up more money as collateral to limit potential losses. This process is known as a margin call. So basically, what happened is this hedge fund, known as archagos capital, leveraged up their positions by using margin margin is like borrowing, money from a bank or a broker to invest margin can increase your returns, but it can also cause you to lose more than hundred percent Of your total investment, in which case you would actually owe the money to your broker.
It works like this say i have ten thousand dollars in cash to invest. My broker may allow me to use margin and loan me an additional ten thousand dollars to buy stocks with which results in me having a total of twenty thousand dollars in buying power. So now, instead of being able to only buy 100 shares of a 100 stock, i can now buy 200 shares and double my position size using margin. This is all fine and dandy and great if the stock goes up to 200 a share because i am producing more returns than i would have been able to if i was not using margin. However, if the stock goes against, you and let’s say it drops down to 40 a share, then my 200 shares are now only worth a thousand dollars, which means that the total value of this investment has lost about twelve thousand dollars. So now my broker notices that my position is losing lots of money and it forces me to close it. This right here is called a margin call, but remember i only had ten thousand dollars in cash to begin with. So now that my loss has exceeded my total account size i’m left owing my broker, an additional two thousand dollars, which also results in me having a loss of over one hundred percent, because i lost my initial ten thousand dollars and now i am left owing another. Two thousand now, if i do not have that two thousand dollars extra in cash to pay my broker, then the broker also ends up taking a loss as well.
So this hedge fund, leveraged up on margin, huge and it’s, actually reported that they were at five times. Leverage which is just insane the investments ultimately went bad bad enough that the banks had to do a margin, call and lost billions of dollars in the process. This is why credit suisse, a large swiss bank, is down over 12 at the time. I’Ve been recording this video because they were one of the banks, loaning money on margin and are now taking huge losses from doing so. But why is this bad for the overall market like? Why was this sending stock prices down so much across the board and causing so much fear earlier on today? One reason is because margin debt is currently at an all time, high of 813.6 billion dollars, which is up from 798.60 billion last month and up from 545.13 billion one year ago. This is a change of 1.89 from last month and a 49.26 percent increase from one year ago. Another chart shows us that margin has also been skyrocketing at a record pace since the crash back in march of 2020, and once again it is currently sitting at an all time, high the more margin there is in the market, the more debt there is as well And ultimately, more risk margin also kind of works. Like a house of cards, if stocks start slipping or going down, and a lot of investors are on margin, then we can see a lot more margin calls starting to take place once someone gets margin called.
It means that they have to sell their stocks. This selling creates more downward pressure, which generates more margin, calls which causes more selling, which causes more margin, calls and so on, and so on. The second reason why this is creating fear is because banks just lost billions of dollars and to cover some of these losses, they may have to margin call other investors and get some of their loan money back as well. Once again, this kind of creates, like our margin, call negative feedback loop, because once banks start losing money, they start margin calling people which causes more selling, which causes more margin, calls etc, etc. So this is why investors are worried about seeing major margin calls going on and why stocks were selling off so hard earlier today. What i think we could potentially see is the stocks that have more margin in them selling off more than the overall market. If investors and brokers start getting more worried about margin, then we could see them lowering their margin exposure. Naturally, this would mean that stocks with the most margin would most likely get hit the worst from this. I personally never recommend using margin, because i don’t think that borrowing money to invest is wise, and i also think that taking away your ability to make a decision on when you want to sell a stock is incredibly risky. When you invest on margin again you’re taking away your ability to make a decision, but what, if the stock dropping, is really just an opportunity to buy more and you’re being forced to sell going on margin takes away your ability to make this decision? And again, i think that it is incredibly risky.
All stocks see volatility too, and every stock in the market is going to see its stocks go down quite a bit at some point and growth stocks more than many other stocks. It is not unusual to see a growth stock fall by more than 50 percent or more in the short term. I mean just go: take a look at amazon’s chart over the past 20 years and take a look at how many times amazon stock has lost more than 50 percent of its value so to invest in stocks, especially growth stocks on margin is almost guaranteeing a loss At some point, if the stock sees some sort of selling and the loss will most likely be a big one, as i am making this video, the market is recovering nicely from all of this fear. But i still think that the increased margin in the market is creating an overhanging risk to stocks. This chart right here shows the relationship between the overall market and margin. The margin is the red line and it is inverted. Historically, one margin would grow, so would the risk in the market when margin was sitting near historical highs, it was usually a good indicator that the market would be due for a major drop or a correction of some sort. We can see that both in the tech bubble and in 2007 right before the great recession margin, was at a peak right before both crashes. Once again, here we can see that margin has skyrocketed and is sitting right at an all time high.
This simply means that there is a lot of debt in the market and if the market starts going down, then these margin calls could only add to the downward pressure now i’m, not saying that all of this margin is going to lead to a crash. But what i am saying is that if we do see some sort of correction or crash in the future, then all of this margin and all of this potential margin calls are going to add to the downward pressure of that crash. And this is a fact all of this margin and the market is going to cause additional selling. If we do see some sort of correction, this is also incredibly dangerous for any financial institution that is allowing their clients to just leverage up on all of this margin and, ultimately, what i see all of this increased margin in the market, as is a total lack Of fear and an increase in greed, if no investors are fearful of the downside and they’re incredibly greedy, then that is when margin is going to start skyrocketing, and i imagine that all of the money, printing and government stimulus is where this mentality is spawning. From i mean the fed is basically saying that they are not going to allow the market to crash and for stocks to fall. So if they’re saying this, then everyone thinks that stocks have zero risk. This thinking of zero risk in the market is also one of the reasons why the price to earnings ratio of the s p 500 is now sitting at above 40, which it has only done it two times before.
In the past, the forward price to earnings ratio of the s p 500 is sitting at 21.9, which is very expensive and again. This is because there is seemingly no risk to owning stocks right now, however, in the intelligent investor on page 17, it says the intelligent investor realizes that stocks become more risky, not less as their prices rise and are less risky, not more as their prices fall. This means that as the price of stocks and the overall market continues increasing, so will the risk associated with them. This is because behind every single stock in the market is a real business and as the price of stocks continue increasing, the underlying businesses need to perform better to justify the higher prices. Essentially, the higher stocks go, the better the businesses need to perform and the lower stocks go, the less the business needs to perform on page 83 of the intelligent investor. It also says, as the enduring antidote to this kind of bull market bologna graham urges the intelligent investor to ask some simple, skeptical questions. Why should the return of stocks always be the same as their past returns when every investor comes to believe that stocks are guaranteed to make money in the long run, won’t the market end up being wildly overpriced, and once that happens, how can future returns possibly be High doesn’t, this kind of sound like the market we are in today. If everyone thinks that stocks are risk free, then the market becomes incredibly overvalued and if stocks become incredibly overvalued, then how much returns can we expect in a short to medium term, stocks simply cannot keep going up at the rate they have over the past year.
Just think about how expensive the market would be if we completely repeated 2020 all over again, charlie munger has also been saying that he believes the returns we should expect on stocks over the coming years should be much much lower. The way i like to think about this is the higher the market goes in the short term, the more future profits we are taking away. Eventually, i do think that things are going to have to return back to normal, and i think that we already are starting to see fundamentals start to matter in the market again. However, i do think that we are going to see elevated price to earnings ratios until all of the stimulus stops and interest rates do start increasing again. But i do not think that the market is going to produce those massive returns that we saw in 2020. Again in 2021 and in the coming years, and eventually, i do believe that we are going to see some sideways trading in the market or a continued downtrend until all of the fundamentals of these businesses catch up to their current valuations, just based on everything. I’M. Currently. Reading and seeing in the market, it sounds like. Everyone believes that there is zero risk right now and the intelligent investor says that when this happens, there’s actually a lot of risk in the market and we’re, seeing that in price to earnings ratios both current and forward. So personally, i’m going to be much more careful with my investments this year and going forward until the market comes down or fundamentals catch up to the valuations.
Today i have to admit that 2020 was fun and speculating in the market and seeing 100 returns. That quickly was a good time, but again, i do think that now we are entering a period where fundamentals are going to matter again. So now, i think, is the time to focus on strong, fundamental investing, and i do think that fundamental investors are going to outperform the market this year and for years to come, but that’s just my thoughts on the market right now, and also all of this margin Talk that was going on in the market and creating fear today, but let me know what you all think down in the comment section below also, if you enjoyed this video, then please remember to leave a like on it. Leaving a like on the video really helps out my channel, and i really appreciate it if you’re not subscribed to the channel, and you want to stick around and see more content like this, as well as all the future content that i produce then well consider subscribing.