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AI stock mania drives record highs in US, South Korea, Taiwan and Japan, margin debt hits 1.4 trillion, leveraged ETFs surge, raising fears of dangerous leverage and volatility
Wall Street’s AI Rally Is Driving Record Flows Into Leveraged ETFs
Fueled by the artificial intelligence (AI) boom, stock markets across the US, South Korea, Taiwan, and Japan have climbed to record highs over the past year. The rally has been driven by strong investor demand for AI-linked companies, including large language model (LLM) developers and semiconductor and chip manufacturers.
The craze to invest in AI stocks is so high, especially in South Korea and now the US, that investors are borrowing money at an unprecedented rate to invest in the market. According to a report by the Wall Street Journal (WSJ), attributing Finra data, US margin debt rose 54 per cent to a record $1.4 trillion in May from a year earlier.
The margin debt is the money an investor borrows from a brokerage to buy stocks.
The WSJ report added that high-risk leveraged ETFs that produce double or triple the daily move of underlying stocks are growing rapidly, along with trading in options tied to them.
Mark Hackett, chief market strategist for Nationwide’s investment management group, as quoted by WSJ, said: “I’m fearful that we’re building unintended leverage that isn’t fully understood.”
“You’ve got people with a lottery mentality using margin to buy options on levered ETFs. That’s three or four layers,” he added.
The WSJ report stated buyers ranging from hedge funds to teenagers on Robinhood are pouring money into leveraged ETFs this year, highlighting that the assets in these funds have doubled to a record $220 billion between March 30 and June 03.
Some of the popular investment stops among investors in the frenzy are indexes of technology and semiconductor stocks, along with individual companies like Tesla, Nvidia, and SpaceX.
SpaceX, Elon Musk’s space exploration company, got listed on the Nasdaq stock exchange at $135 per share. Despite being considered overvalued, shares extended another 19 per cent to touch $161 per share mark on the very first day of listing as investors rushed in FOMO (fear of missing out).
Thereafter, shares touched the record $201 per share, up almost 63 per cent from the IPO issue price. Following the rally, shares slumped to come down at the level of $150 per share.
Broader Problem Emerging At Wall Street
The WSJ report highlighted that a broader problem is emerging, according to market observers, due to the massive inflow of money into high-leveraged funds.
These funds, along with other forms of leverage, can also affect how the individual stocks behave, according the report, adding to the recent action in South Korea that offers a glimpse at the risks.
The report attributing Barclays analysts estimate stated that leveraged funds have bought some $300 billion in derivatives linked to single stocks and indexes since the end of March, amid a bid to keep pace with the flow of new money.
Those purchases have in turn spurred demand for underlying shares from market makers, which buy stocks to hedge their exposure to the derivative contracts they write, it added.
The WSJ report pointed out that when stocks fall, leveraged funds lose assets. “That forces them to reduce exposure to the shares they track, which in turn threatens to pull down stock prices even more, according to the report.
There is a danger, that this cycle can quickly spiral into heavy losses.
“That’s a somewhat terrifying figure to contend with should it need to be unwound in a short period of time,” Alexander Altmann, global head of equities tactical strategies at Barclays, told clients on Wednesday. “This is without a doubt the largest nondiscretionary driver of risk at the moment.”
Large leveraged funds can eventually influence the movement of the stocks they are meant to track, a situation traders call “the tail wagging the dog.” With volatility increasing, especially in semiconductor stocks that see heavy activity in leveraged ETFs and options, analysts are taking a closer look at how leverage may be affecting market movements.
About the Author
Varun Yadav is a Sub Editor at News18 Business Digital. He writes articles on markets, personal finance, technology, and more. He completed his post-graduation diploma in English Journalism from the I…Read More
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