Inflation risk has soured one investor away from bonds and into stocks
Margin debt isn’t a red flag for one investor.
One of the explanations put forward recently for the record-breaking rally in the U.S. stock market was the equally record-breaking amount of margin debt that had been incurred in the process. Money borrowed to invest in shares topped $1 trillion in August.
For Brian Jacobs of Aptus Capital, however, this is not the five-alarm fire it sounds and is less ominous than investors might suspect. Economist David Rosenberg posted on X a few weeks back that the number was “pretty scary” but Jacobs contends it’s merely a coincident indicator, a symptom of the market’s meteoric rise, rather than a signal of its imminent demise.
Jacobs writes in a recent investment blog: “It (margin debt) moves with the market. When equities rise, account values increase, and investors naturally take on more leverage. Margin debt rising 25% over the last year? The S&P 500 SPX is up about the same. Margin debt has almost doubled over the last five years? The S&P 500 is up about the same.”
Jacobs expresses skepticism about the predictive capabilities of measuring leverage in the market: “As a standalone warning sign it’s misguided. Most of the time it’s just a by-product of rising markets” and he points out that it won’t correctly forecast when the next correction will hit.
Moreover, Jacobs contends that the U.S. actually boasts a “very low level of margin debt normalized against the market cap of U.S. stocks.”
Margin debt and Wilshire 5000
Founded in 2013, Aptus Capital Advisors is headquartered in Fairhope, Ala. and specializes in risk-mitigated investing. At present, the overall slant of the fund’s approach is to be overweight equities and underweight fixed-income, especially instruments of longer duration. “Fixed income is in trouble. More stocks, fewer bonds,” was his summation.
Bonds he pointed out have delivered very poor returns in recent years, “roughly zero percent over the last century” and the spread of investment-grade debt over U.S. Treasurys is the tightest this century, offering very little value to investors, he posits. He raises the example of buying long bonds BX:TMUBMUSD30Y on a 5% yield, losing 3% to inflation and then being taxed annually on something which only delivers returns on a long-term basis.
Aptus recommends using option strategies to complement stock selection or fixed-income investments, often using exchange-traded-funds (or ETF) wrappers. For example, its flagship hedged equity product, the Aptus Collared Investment Opportunity ETF ACIO, will pursue growth opportunities in stocks while selling covered calls on those stocks to generate some additional income while using long-dated index put options on an index for protection.
The fund this year has gained 5% – half the S&P 500’s returns. Over 5 years, the fund has had annualized returns of 10%, according to Morningstar, which puts it in the top tenth of its peers.
Jacobs’ investment philosophy focuses on capturing most of the upside when the market is rising but minimizing the downside when it’s falling. Investors don’t mind, he points out, missing out a little when their portfolios are doing well so long as they fare far better when they fall.
Tax-mitigation strategies, he adds, are almost as important as the investment choices themselves.
Most recently, Jacobs has been preoccupied with developing tactics to manage “purchasing power erosion,” or the twin threat of dollar debasement and long-term inflation. To that end Aptus have developed a what it calls a purchasing power protection sleeve which incorporates bitcoin (BTCUSD) and gold (GC00) on a 70:30 ratio.
-Jules Rimmer
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