Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / How Bull Markets Hide a Hidden Leverage Risk
Transcript
- Lucas: Luna, the S&P 500 is sitting at 7,682, up something like 18% from a year ago, yet over the last five trading days it's down 0.8%. The Nasdaq's off 1.6%. And none of that feels like a story, because the bull market has trained us to look through pullbacks. Luna: Right, but CrowdStrike dropped nearly 11% in the same window. That's not a whisper, that's a scream. What's going on under the hood? Lucas: That's exactly what I want to dig into. Because while everyone's watching the headline index crawl higher, there's a build-up of hidden leverage in this market — in corporate balance sheets, in ETF structures, in margin accounts. And it's the kind of thing that doesn't show up in a calm tape. Luna: I mean, we talked about the VIX being quiet back in episode 148. Is this the flip side of that? Lucas: It is. The VIX can stay low while leverage quietly compounds. Think about leveraged ETFs, for example. These products let retail investors get two or three times the daily return of an index or a sector. In a bull market, they feel like a cheat code. But the daily rebalancing means they're structurally short volatility. When things turn, they can amplify a sell-off in ways that feel disproportionate. Luna: And we saw that with the ARK Innovation ETF — it's up 5.6% in five days while the Nasdaq is down 1.6%. That kind of divergence is a warning sign, not just a headline. Lucas: Exactly. The crowd chasing momentum into ARKK, which holds a lot of unprofitable tech, is taking on a different kind of risk than someone in a plain S&P 500 index fund. And the data shows margin debt has been creeping back up — it's now around $900 billion, not too far from the 2021 peak. That's borrowed money betting on more upside. Luna: So when the S&P drops 1% on a random Wednesday, margin calls force selling, which feeds the drop. It's a feedback loop. Lucas: Right. And that's the hidden leverage angle. It's not just the obvious stuff like hedge funds using derivatives. It's everyday investors who don't realize their ETF has an embedded leverage component, or that their brokerage account allows them to borrow against their holdings without a second thought. Luna: I read that the average margin debt per account is something like $15,000 now. That's real exposure for a lot of families. Lucas: It is. And the thing is, in a bull market, it feels rational. You're leaving money on the table if you're not using some leverage. But the math changes fast. If the market drops 10% from here, a 2x leveraged ETF holder could see a 20% hit, and that's before the volatility drag that comes from daily rebalancing. Luna: Let's talk about that volatility drag. Because I think people hear 'leveraged ETF' and they don't realize the daily reset means long-term returns are often worse than the underlying index, even in an uptrend. Lucas: That's the dirty secret. A 2x leveraged S&P 500 fund might deliver something like 1.8x the index's daily move, but over a year, the compounding of daily rebalancing eats into returns. In a choppy market, you can lose money even if the index ends flat. That's not a bug, it's the product design. Luna: And we're seeing that in real time with some of these high-flying names. Shopify's flat over five days, Datadog's down 5.7%, Cloudflare's down over 5%. These are the kinds of stocks that get hit when leverage unwinds. Lucas: Exactly. And that's the thing about hidden leverage — it doesn't announce itself. It lives in the positioning of momentum funds, in the margin statements of retail traders, in the balance sheets of companies that took on cheap debt to buy back stock. Luna: So let's talk about corporate leverage for a second. We've seen a record number of buybacks this year, right? Some of that is funded with cash, but a lot is debt. Lucas: Right. Investment-grade corporate debt is up to about $11 trillion, and a good chunk of that was issued at low rates in 2020 and 2021. Now, with rates at 3.6%, refinancing that debt is going to cost more. Companies that used leverage to boost earnings per share might see that reverse. Luna: And that's exactly the kind of thing that doesn't show up in the price to earnings ratio. You can have a stock that looks reasonably valued on trailing earnings, but if those earnings were juiced by buybacks funded with debt, the quality of those earnings is lower. Lucas: That's a really important point. And it's why we're seeing this polarization in the market — the haves and have-nots we talked about back in episode 156. Companies with strong balance sheets are doing fine. But the ones that loaded up on leverage and expected rates to stay at zero are starting to feel the pinch. Luna: So what does this mean for the average investor who's just in an index fund? Are they exposed to this hidden leverage? Lucas: They're exposed indirectly, through the companies in the index. And they're exposed through their own behavior — if they've been using margin or buying leveraged products without fully understanding the mechanics. But the good news is, you don't have to avoid the market. You just have to know what you're holding. Luna: So the takeaway is maybe not 'sell everything,' but 'check your own hidden leverage.' Lucas: Exactly. Look, I'm not saying the bull market is over. The economy is growing, real GDP is up, and corporate earnings have been resilient. But the risk profile is different than it was two years ago. And the smart investor is the one who understands where the hidden landmines are. Luna: It's like, you can enjoy the ride, but you should know if you're sitting on a beach ball that could pop. Lucas: That's a great analogy. And that's the kind of conversation we love to have here — not fear-mongering, just clear-eyed analysis. Luna: And a quick honest thing — a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. Lucas: Yeah, it's a small group, but they make it possible for us to keep these conversations ad-free. So if we've helped you think about your portfolio differently, that's the place. Luna: And we're back to it — because the last thing I want to leave you with is the idea that leverage is inherently bad. It's not. It's a tool. But like any tool, you need to know how to handle it. Lucas: Well said. So as you look at your own investments, ask yourself: am I using leverage, and do I really understand the mechanics? Because in a bull market, that question is easy to ignore. But when the tide turns, it's the only one that matters.