Leverage (aka debt) is a great tool in rising markets, but can be catastrophic in market meltdowns.
Given the low interest rate environment, businesses, institutions, and individual investors have been borrowing more and more collateralized money via large mortgages, margin, line of credit against stocks/crypto, business loans, etc. If the value of the collateralized investment (homes, businesses, stock, crypto etc.) drop, lenders (banks) can and will make a capital call and force the sell of those pledged assets. This process of forced selling to cover debt can create a spiral effect of rapid price reduction in stocks/crypto and in turn housing as investors are forced to sell further and further reducing the market price of the asset (based on forced need to sell versus fundamentals.)
We have seen this rapid sell off happen in crypto several times this year and yesterday’s stock market/China sell off gave a little taste of what could happen to stock investors who are over-leveraged.
Do I think the China’s Evergrande debt issues will lead to a global credit and equity meltdown tomorrow or next week? I think it is a risk worth being aware of, but I am confident in our global banking system’s liquidity and in the accommodate monetary policy environement which will serve as a shock absorber. Corporate earnings are also extremely robust validating current equity valuations. Real estate pricing on the the hand is artificially inflated due to access to dirt cheap interest rates (I just closed on a 15 year fixed mortgage at 1.8%!)
I do still like stocks, crypto, housing, and other investments and am remaining invested, but it is a good time to capture some of your liquid gains and reduce your debt/leverage across your portfolio as a risk management tactic.