The U.S. stock market may soon experience a moment of "situational awareness."

At the very least, this is the worst-case scenario that some analysts on Wall Street are discussing. As they pay more and more attention to a startling statistic in the market: the debt from margin trading held by investors has risen to record levels, and the recent growth rate is only seen before major corrections.

They worry that if there is a significant sell-off in tech stocks, it could ignite the "fuse" of this record-breaking loan, triggering margin call notifications, which in turn could lead to a wave of forced sales and disrupt the momentum of the bull market.

Investors regarding Business Insider say that this scenario may sound unlikely, but the risks are indeed on the rise, and investors need to be prepared for it. This is especially true given the high concentration of the market in tech stocks and the significant exposure of American households to sudden drops in stock prices.

Investors who use margin trading can buy stocks or investment products by borrowing from brokers. However, if the value of their holdings falls below a certain threshold, they will receive a notice to add more margin to their margin account. If they are unable to make up the shortfall, the broker may sell their holdings, which can sometimes result in losses for the investors.

This is precisely what dragged down the South Korean stock market this summer. South Korean retail investors have a high leverage ratio, and when chip and storage stocks began to fall in the summer, they faced a wave of margin calls, which in turn triggered a chain reaction of forced sales.

The same dynamics also led to the collapse of Situational Awareness. This is a high-leverage hedge fund managed by Leopold Aschenbrenner, a rookie from AI. After heavily betting on chip stocks, the fund received a margin call this summer.

According to FINRA data, the debit balance in customers' securities margin accounts reached a record $1.5 trillion in June.

Although this level has slightly declined since the summer, it remains high. In August, the debt from margin trading amounted to 1.4 trillion US dollars, an increase of about 27% compared to the same period last year.

BCA Research Chief Economist Peter Berezin stated to Business Insider, historically, a decline in margin trading debt from high levels is usually a warning sign for the market. When margin trading debt begins to fall, it typically indicates that future returns on stocks will be lower. He added that if margin trading debt drops significantly from its summer highs, he would be concerned about a wave of deleveraging.

“Once this situation begins, it tends to self-reinforce. As investors deleverage, it means they have to reduce their stock exposures; this will push down stock prices, which in turn triggers a new wave of selling,” he said.

Berezin indicates that investors may now be more vulnerable to such sell-offs than in the past. He pointed out that several concurrent vulnerabilities could make this scenario even more dangerous:

• The market has a high concentration of technology stocks, which means that the wave of deleveraging could be triggered within the technology sector and have a significant impact on the broader market. Currently, the information technology sector accounts for about 40% of the S&P 500 index.
• Americans are more exposed to sudden drops in the stock market than in the past, partly because family stock holdings are relatively large. Data from the Federal Reserve shows that American households held a record $64.6 trillion in company stocks and mutual fund shares in the second quarter, accounting for more than one-third of the total national household wealth.
• In recent years, with the emergence of a large number of leveraged investment products, more investors have been exposed to leverage risks. A survey in September by Yahoo Finance - Harris found that 43% of American investors are using leveraged trading, such as trading options or buying stocks on margin. Bloomberg data shows that leveraged ETF assets also reached a peak of approximately $200 billion this summer.

"From this perspective, the risk of this stock market is even higher than in 2000," said Berezin.

Baird Private Wealth Management, an investment strategist and vice president, stated to Business Insider that the record levels of margin trading debt indicate that the rapid decline seen in the South Korean stock market this summer could also occur in the United States.

"I do indeed believe that the market structure might be a bit more fragile, as we have introduced too many types of leverage into the market," he said, but he also pointed out that this is not a threat to the market's viability.

Measured from different perspectives, the current level of leverage appears extreme in historical terms. Calculated as a proportion of financing and securities lending debt to the total market value of the United States, it is still close to the historical average of 2%; however, when measured as a ratio to the M2 money supply, the financing and securities lending debt has reached a level comparable to that of 2008 and before the bursting of the internet bubble. This is pointed out in an analysis by the financial services company CGS International in March.

Analysis by Ameriprise Financial reveals that since 1997, there have only been three years when the year-on-year growth rate of margin trading debt has been so rapid: 2000, 2007, and 2021, and all three of these years preceded significant market corrections.

Ameriprise Chief Market Strategist Anthony Saglimbene described a scenario where the record concentration of tech stocks combined with record leverage led to a "self-reinforcing" sell-off, impacting the most concentrated stocks in the market.

In a memorandum, he wrote: 'When participants using leverage all hold the same underlying asset, and this trend is still on the rise, both upward and downward pressures could lead to greater market volatility, which seems to be inconsistent with the development of headlines.'

Berezin says that if forced selling really begins, investors will have almost no clear safe havens. He pointed out that the deleveraging process during the bursting of the internet bubble occurred in two stages: The first stage appeared at the beginning of 2000, when funds shifted from technology stocks to other sectors, and investors were still able to find safety by moving into other industries within the market.

The second phase began in 2001 with a widespread market sell-off, and all sectors were severely hit.

Berezin says that the market seems to be moving towards a "rotation" phase, referring to the recent selling off in the chip and storage sectors. He speculates that a broader market sell-off similar to that of 2001 may not occur for at least another few years.

"It may still be too early to issue an alarm now, but it's not too early to start worrying about the possibility of things worsening. Because once they do worsen, I believe that situation will self-reinforce," he said.