Japanese stock market shows dangerous signal from 1990

Margin trading in Japanese stocks is rising to its highest level since 1990. Investors continue to borrow money to buy stocks at record highs, while financing costs are simultaneously rising. That creates a dangerous combination that is reminiscent of the period just before the major Japanese stock market crash of the 1990s.

In short:

• Margin trading in Japan reaches its highest level since 1990, just before the historic stock market crash
• The Bank of Japan is raising interest rates after decades of ultra-cheap money, making leveraged positions more expensive
• Forced selling during a correction can quickly accelerate a normal decline

The same pattern as before the 1990 crash

Data from the Japan Exchange Group and Goldman Sachs Global Investment Research shows that net margin trading in Japanese stocks currently stands at around 6,000 billion yen. That is the highest level in more than 35 years. The last time this figure was so high, the Japanese stock market collapsed by more than 80%.

The major difference from the situation in the 1980s and early 1990s is the central bank’s policy direction. Money was virtually free in Japan for years, but the Bank of Japan is now raising interest rates after decades of ultra-loose policy. That makes it much harder for investors using borrowed money to hold their positions.

High debt position increases the risk of a snowball effect

A high level of margin trading not only pushes prices higher, it also makes any price decline more dangerous. When investors can no longer finance their positions, they are forced to sell. Those forced sales can quickly accelerate an ordinary correction into a much larger decline.

The pattern is recognisable to anyone familiar with the history of the Japanese market. When confidence turned in 1990, the high leverage in the market caused the downturn to be dramatic. Whether history is now repeating itself is uncertain, but the current combination of record-high debt positions and rising interest rates is a signal that analysts take seriously.