Animal spirits are loose on Wall Street again, and this time they have discovered artificial intelligence.
We have not quite reached the 2021 SPAC circus, when every celebrity with a podcast and a blank-check company seemed ready to reinvent transportation, finance and breakfast cereal. But the AI trade is beginning to give off the same vibe.
Margin debt is spiking, but remains under the peak levels seen at prior market peaks. (Source: The Leuthold Group/CNBC)
Margin debt has jumped more than 50% year over year, even as interest rates remain stubbornly high.
That tells you investors are not merely enthusiastic about the AI trade. They are enthusiastically borrowing money to buy AI at a record pace. Margin is great on the way up because it lets you buy more stock than your cash would otherwise allow.
On the way down, it becomes a piano wire. A modest pullback can force selling, and forced selling has a nasty habit of turning a manageable decline into a trapdoor.
Andrew and I looked at a useful tool for evaluating the higher end of the S&P 500 Index yesterday during our Grey Swan Trading Fraternity livestream.
South Korea’s KOSPI market has been dominated by a narrow memory-chip story, with just two companies accounting for more than half the index. Heavy margin use and huge volume in triple-leveraged ETFs have driven the index to historic highs. But high concentration of a technology story that sounds too good to doubt has attracted massive speculation on debt.
When the market spikes like the KOSPI has, you can be sure the downside selling will be just as severe. Margin works for you on the way up… against you on the way down.
For the U.S. market, the signal to watch is not merely bad news. Late in a speculative run, the more telling moment comes when the market stops rising on good news. Earnings beat, the stock stalls. Guidance improves, the stock yawns.
Another AI headline hits the tape, and traders begin looking at each other as if someone forgot the next line in the play. That is often when it makes more sense to cash out your winnings than to roll them into one more hand.
There is, however, a quieter — cleverer — way to play the speculation: own the exchange. Brokerage firms profit from high-volume trading, margin lending, customer activity and the general human weakness, greed and fear.
The trading exchange industry is an oligopoly, dominated by a handful of major firms. The best operators can produce profit margins in 40% range. They do not need every trader to win. They only need traders to trade.
One brokerage firm in the Grey Swan model portfolio has been a consistent winner during the AI bull market. It got sold off during the banking crisis in March 2023, so we bought more. In a high-volume, high-speculation market, the casino is a better business than the gambler’s strategy.
Even when customers are learning the hard knocks, that leverage cuts both ways; the brokers collect fees, earn spreads and finance the rush for the exits.
Today’s Grey Swan Pro looks at an early company benefiting from the animal spirits running rampant in markets today — with high margins, it’s building out a pipeline of profit from future trends in investing and trading — details here.
~ Addison
P.S. This afternoon on Grey Swan Live!, we return to one of our favorite themes: Argentina’s economic turnaround. While DOGE met the Washington establishment and the establishment won, Mieli’s Argentina has truly taken a chainsaw to the administrative state.
We’ll get the latest from our man on the ground, Joel Bowman, author of Notes From the End of the World.
