Margin Debt: Will it revert or continue to rise?

Written August 9th, 2013

Zerohedge.com had a very interesting article earlier today summarizing a new research piece by Deutsche Bank about the current level of margin debt and the stories on said margin debt. In particular, the report looks at articles in 1999 and 2007 for correlation with today’s headlines.

As DB says, “we prepared a collection of press articles which were published around the key events during the past financial crises. Our key finding is straight forward. Irrespective of the publishing date, the articles read alike throughout the two major crisis periods, i.e. the “new technologies market equity bubble” (1999-00) and the “Great/Global Financial Crisis” (2007-08). Most interestingly, literally the same content can be found in todays’ press. Universal phrases include:

  • “A rising stock market encouraged more investors to go into debt to buy stocks, sending margin debt levels past their all-time high”.
  • “The National Association of Securities Dealers (NASD) has asked members to review their lending requirements in a sign of increasing concern that rising levels of margin debt could exacerbate a stock market plunch.”
  • “The Fed is concerned about a sharp rise in margin debt but has been unwilling to attack stock market speculation as high levels of leverage do not necessarily translate into high risk. The last time the Fed adjusted the margin rules was in 1974, when when it reduced the down payment required for stocks to 50 percent of the purchase price, from 65 percent.” […] “The Fed should return to its pre- 1974 policy of actively changing margin requirements in response to stock market speculation”.
  • “High margin debts show the effect of over-leveraging and mispricing of risk”.
  • “The movements in stocks cause brokerages to stop allowing customers to buy some of the volatile stocks on margin or require clients to put up more cash.”
  • “Either the market rises dramatically to make those loans good or in any down move there is tremendous selling pressure”.
  • “Until recently, most investors ignored red flags raised by regulators”.

I’m presenting this without further comment for the time being.

Relevant ETFs: SPY, SH, IWM, RWM

Flippin’ Treasuries

Written August 6th, 2013

Short note on slowest day of the year…

Back in 2007, flipping houses was all the rage. The idea was to buy a house, or better yet a preconstuction property, and “flip” it for a quick capital gain, with maximum leverage. Simple.

Well, who’s buying treasuries now? Flippers. Why do I call them flippers? With 10 year rates under 3%, on the margin, people buying treasuries at this point aren’t buying them for the 3% income, which means they’re expecting rates to go lower and thereby reap some capital gains on the trade. Flippers.

Nothing wrong with a trade and nothing wrong with capital gains. When Jeff Gundlach talks about rates going lower, he’s talking about making a trade. When a retiree’s financial advisor buys her a 60% allocation to fixed income, that financial advisor thinks he’s making an asset allocation “investment,” but in reality, he’s just taking a speculative position that no investor would like to hold on to for the next ten years.

So for those allocating to treasuries, just recognize that you’re in it for capital gains and not income. Remember that some people made a lot of money flipping houses, but someone got left holding the hot potato circa-2008. Make sure it’s not you.

Relevant ETFs: TBT, TLT

 

Story of the Week: Margin Compression

Written July 30th, 2013

Everywhere I turn, it’s Case-Shiller Housing prices increased here, increased there, what will higher mortgage rates mean for the next data point, etc. The Case-Shiller index is good for a long term series, but the data being released is for months ago. Today’s most important story has nothing to do with housing and everything to do with the coming valuation disconnect, namely, however expensive the P/E looks now, it will look even more expensive if prices continue to go up as profit margins come down.

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Housing and Finance

Written July 26th, 2013

I will admit that I have never run a bank, although I’ve loaned out money to family and friends to varying degrees of repayment success. It’s thus from an armchair perspective that I’ll boil down the banking business into a simple model: borrow short and lend long. Borrowing short comes from deposits, and lending long comes from mortgages. We can then add one more layer of complexity.

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To Taper or Not to Taper, That is the Question

Written July 24th, 2013

Everyone is talking about The Taper! Have you heard? Good news might mean that the Fed will taper. Should we then hope for bad news so the taper won’t happen? Is the Fed (and Obama & Co.), then, in a position to root for higher unemployment so their hand isn’t forced yet?

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A growing divergence between oil and stocks

Written July 2nd, 2013

The summer doldrums are here, regardless of last week’s volatility. For starters, no one wants to look at the markets when everyone else is out barbecuing. More importantly, there are so many diverging signals that no one wants to take large positions (e.g. do you go long Apple here or not? Will the Fed step up QE or not? Was that ISM figure positive or not?). Similarly, bonds seem to have found a bit of stability and are looking for direction. And yet, the secret is in the divergences we are starting to see.

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Gold miners – Catching a falling knife or getting in before the turn?

Written June 26th, 2013

The markets are up. The markets are down. In the space of a few weeks, we’ve seen giants fall (is it true that Bridgewater is down 8% for the month? or, if Apple and gold are down, is Einhorn getting a margin call?). Even bond guru Jeff Gundlach is being forced to host special, off-schedule conference calls after announcing he’s buying treasuries into the weakness. They’re not wrong – they just didn’t read Stanley Druckenmiller’s brilliant summary of the current situation.

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Perspective on a painful day

Written June 20th, 2013

The S&P was off 41 points today and closed below the psychologically important 1,600. It was a painful day, with no place to hide. Stocks were down, but so were bonds, commodities, international markets, gold, etc. Not much green to be found. On the flip side, let’s keep some perspective. Here’s a chart of today’s move.

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On China

Written June 20th, 2013

I have been a China bear for longer than an ETF existed to play the Chinese rise. Visions of Russian propaganda farms kept creeping in to my interpretation of Chinese growth figures. When news of ghost towns first emerged, my response was a simple, knowing shrug. But now that the market is off about 25% for the year, news of a credit freeze is trickling out, and luxury makers are lowering growth forecasts, I can’t help but look to the Chinese markets for some value.

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So do you want rates to rise or don’t you?

Written June 4th, 2013

I’m confused. If zero rates are so bad, why will it be bad if rates rise? Asked another way: If you paint yourself into a corner, how do you get out without stepping on the floor? Answer: Simple – you don’t. Zero rate ARE bad and it WILL hurt when they rise, but it doesn’t mean they shouldn’t.

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Why not short treasuries?

Written June 3rd, 2013

I know you’re tempted to short treasuries. From 1.70 to 2.17 on the 10-year in no time at all. Who knows how much further it can go. Maybe we’ll even see 4% rates in our lifetime again. But don’t, and here’s why.

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Gold performance during times of deflation

Written May 16th, 2013

Everyone is absolutely certain they know what gold will do in times of inflation – obviously we’ll have a repeat of the 1970′s when gold gained in relative value terms, kept its purchasing power, and provided a hedge against inflation. With this backdrop, it is not surprising that the recent talk of deflation has hurt the yellow metal’s price. But is that warranted? 

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If leverage is free, is every price reasonable for real estate?

Written May 7th, 2013

Here’s the dilemma – you see a house selling for a certain amount and realize that it doesn’t cost you much to finance it, because your carrying costs are low. Does that mean that you should buy it even if the price is absurdly high? More and more advisors, articles, and pundits are suggesting that you should, and I just can’t jump on that wagon. Here are just a few of the arguments I’m hearing:

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Gold, repo rates, and backwardation

From the FT.com:

The conspiracy channels continue to make a big deal about the backwardation of gold — which is a situation in which gold prices for today are higher than for tomorrow. The thinking is that this must indicate rampant demand for physical gold.

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Value indicators are hard to time, but shouldn’t be ignored

Written April 30th, 2013

I often write about market valuation metrics, from CAPE to Q, and the conclusion is always the same: they’re all really bad to use as timing factors. On the other hand, for us long-term investors, these factors shouldn’t be ignored and can give us insight into a general bias, or at least give us insight into the risks we might choose to take.

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