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REHeakins
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Private Wealth Manager / Securities Expert / Co-host of "Investing and Your Legal Rights" heard monthly on www.KQV.com. Over 33 years in the investment industry, first working at PaineWebber for almost 20 years which included 3 years as a branch manager. Currently have a CRCP... More
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OakTree Investment Advisors
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Covered Call Focus
  • 6/28/13 Week In Review 1 comment
    Jun 28, 2013 5:49 PM
    06/28/13 Week In Review


    Welcome back to OakTree Investment Advisors' Week In Review. As we close out June and the second quarter, the market is digesting a lot of volatility. News headlines, economic data, and statements out of the Fed are moving markets in violent ways. With earnings coming out next month, we're here to provide you with some news we think you should be aware of going into the third quarter.

    U.S. first quarter GDP revised downwards

    Wednesday saw the second revision to the U.S.'s first quarter GDP figures, and the result was not good. The revision adjusted the GDP increase to only 1.8%, down 0.6% from the previous 2.4% reported last month during the first revision. The weaker figures are mainly due to revisions to consumer spending, exports, and commercial real estate. Out of those three large revisions, consumer spending and export figures are the most troubling as they are more indicative of the health of the economy. If consumer spending is tepid, it means fewer goods are being purchased, which means lower sales, which means lower revenue, which means fewer jobs, and thus less disposable income for spending. When we talk about exports contracting it generally means the ability of an economy to expand is highly restricted, as the global market makes up a good portion of the largest companies' revenues. Goldman Sachs, Barclays, and Nomura economists all estimate that second quarter GDP grew at a pace of 1.5-1.9%; a much lower number than is required to be considered a healthy and robust economic recovery. With continually tepid economic data, as the markets go through their cycles the absence of a healthy support floor that is generated by a strong economy.

    Margin Debt Levels reach pre-crisis highs

    FINRA, the Financial Industry Regulatory Authority, keeps track of the amount of margin debt that are in brokerage accounts across the industry. Margin is borrowed money that an investor takes from their brokerage firm in order to make additional investments. In simple terms, investors take loans from their brokerage company, use the loan to invest in order to make larger gains then they normally would be able to, and then pay back the loan with the gains they end up taking. Obviously, the danger here is when the stock market goes down and investors end up losing more than their initial principal as they have to now pay back the margin to the brokerage firm.

    When the market is doing well, investors clamor for margin, and brokerage firms are happy to lend it out, as they will be able to collect interest on the margin as long as it is invested. As the market does better and better, more and more margin is borrowed. Yet if the market turns and stocks begin to fall, brokerage firms, in order to manage their risk, may raise their margin call levels. These levels are the amount of equity to margin in the account that must be maintained. By default, this level is 25% equity to margin, but if firms feel like there is undue risk in the markets, they can raise these levels. When you combine a raising margin level with a declining stock market, it is quite easy to create a margin call. A margin call is a mandatory liquidation of investments made on margin, or deposit of additional funds, when an investment(s) made on margin break the margin level. If liquidated, these margin calls can end up locking in losses on those investments that are quite devastating. But on a larger scale, there is an even worse outcome.

    When margin calls are made on a wide scale, for large lots of investments, these liquidations can help spiral down the markets as more and more sell orders begin to roll in. These orders end up driving prices down even further, resulting in more and more margin calls. This creates a downward crescendo that ends up helping to contribute to the velocity of a market crash. Recently, we have touched the same margin levels we reached before the financial crisis of 2008-2009. While we can not attribute the financial crash purely to these margin levels and the subsequent calls that became associated with them, we do believe that they were a contributing factor. Here is a graph of the margin debt levels from January 2006 till May 2013, from data gathered from the FINRA website. It is something we will be keeping our eyes on moving forward.

    (click to enlarge)

    Posted by OaktreeAdvisors at 6/28/2013 4:20 PM
    Categories: Week In Review

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    Themes: Margin, GDP
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  • raykrv6a
    , contributor
    Comments (3110) | Send Message
     
    I can't believe Margin went up like that. Oh well, that will clean some people out of the market. There seemed to me lot of trading going on.

     

    Wrote DLR Aug 65 call today for 1.00 when the stock price was 61. Seemed like a decent return either assigned or not called.
    29 Jun 2013, 12:29 AM Reply Like
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