Wednesday 3 September 2014

THE DAILY TELEGRAPH REPORTS "SPECTRE OF 1929 CRASH LOOMS OVER THE FTSE 100 AS TRADERS TAKE ON RECORD AMOUNT OF DEBTS"!!

Spectre of 1929 crash looms over FTSE 100 as traders take on record debts

The spectre of the 1929 stock market crash looms large for UK investors as traders borrow record amounts to invest in rising stock markets

Nothing has been learnt from the madness of the 1929 stock market crash as once again traders reach for record amounts of debt to pile into rising share prices.
The level of margin debt that traders are using to buy shares in the stock market reached the highest levels on record, according the latest data from the New York stock exchange.
US traders borrowed $460bn from banks and financial institutions to back shares, and once cash and credit balances held in margin accounts of $278bn is subtracted this left net margin debt of $182bn in July
Traders are now more exposed to a fall in share prices than at the height of the dot-com bubble at the turn of the century, and just before the financial crisis during the 2007 peak.
Margin debt at record high

Source: Dshort.com
Buying shares on margin is often used by hedge fund traders to increase the returns on their investments. As the stock markets have steadily risen during the past five years and the level of risk has fallen, banks have become more willing to lend money for this activity.
The practice of buying shares on margin can trace its roots back to the heady days of the roaring 20’s stock market boom. Retail investors intoxicated by the offer of limitless gains only had to put down a small portion of their own money to buy shares.
In the 1920’s investors put down between 10pc to 20pc of their own money and therefore borrowed up to 80pc to 90pc of the cost of the investment.
The impact on returns in a rising market is startling. If for example an investor only has to put down 10pc, then with £10 he can buy £100 worth of shares. If by the end of the next day the investment has risen by 10pc to £110, when they sell the shares the returns in absolute amounts would be the original £10 plus a £10 profit, thus generating 100pc return within a day rather than 10pc if they had to put up the whole £100 to buy the shares in the first place.
The problem comes when markets start falling and investors get the dreaded margin call. Using the same example if the shares fall to £80 on the first day the investors entire £10 has been wiped out, plus another £10 of debt he now owes. However, at the end of the day the broker will only call for an additional £2 to be put into the account. If at the end of the following day the shares fall further and the investor cuts their losses, they have to find money to repay their debts.
In the 1920’s many in the stock markets bought on margin, confident that they would gain from the rising market and get out before everyone else started selling.
In today’s stock market the only modification to buying on margin is that the US Federal Reserve currently has an initial margin requirement set at 50pc. The margin debt must remain below specified amounts on each account and not all shares can be bought on margin.
The market participants using debt to invest has also changed, gone are the days of retail investors using margin to boost returns, it is now largely the preserve of professional investors such as hedge funds.
More and more shares have become available to buy on margin as the perceived level of risk within markets has steadily decilined.
A key indicator of risk the Chicago Board Options Exchange Volatility Index, or VIX often known as the investor fear gauge, closed last week at 12.05 points, only three points from a record low.
The hope is that professional investors will not behave as irrationally, and sell shares wildly at the first sign of trouble, as happened in 1929. However, this looks to be wishful thinking on the part of the regulator. If anything the problem of the markets being exposed to sharp falls has only been amplified by the growth in the level of debt used by hedge funds.
The logic of the professional investors also appears deeply flawed as they all believe they can steadily unwind trading positions in an orderly process to realise their gains. However, because borrowing on margin requires positions to be exited quickly to prevent losses; a steady unwinding is impossible. This would be much the same as every spectator at a football game believing they can all make it through the exit at exactly the same time.
As we move into autumn the traders will be returning to the markets and reviewing their positions. This tends to be a volatile period for stock markets. The stock market crashes of 1929, 1987, 2001 and 2008 all happened in September and October.
In fact the anatomy of the 1929 crash is worth reviewing. It started with the Dow Jones Industrial average hitting its peak on September 3. The stock market then started to fall two days later, there was no panic and no crash throughout the whole of September and early October just stock prices failing to make a move higher.
It was on October 24, or Black Thursday, that the market finally fell apart dropping sharply before recovering strongly into the end of the day. The seeds of doubt had been sown and over the weekend investors decided they wanted to get out. When the markets opened on October 28, or Black Monday, there was more sustained selling and no recovery. The collapse culminated in the worst day in stock market history recorded on Black Tuesday October 29, when fear gripped the markets and the lack of any buyers resulted in share prices dropping through the floor.
The Dow Jones hit a record high of 17,154 last week and the S&P 500 has also gone above 2,000 for the first time ever. If investors do start to sell it will be into a thin market. US stock-market volume averaged 5.3bn a day in August, compared with a mean of 6.3bn in the first seven months, data compiled by Bloomberg show.
The S&P 500 has risen more than 22pc in the past 12 months
The Dow Jones Industrial Average has risen nearly 16pc in the past year
In the UK the FTSE 100 hasn’t climbed as high as the US stock markets. The Footsie closed last week at 6,820, still some way short of the record 6,951 reached on December 30, 1999.
As we approach those levels it is worth keeping in mind how far we could fall.
When the dot-com bubble burst at the start of the new millenium the FTSE 100 slumped 48pc to fall below the 3,500 level. As the 2008 financial crisis unfolded the FTSE 100 index dropped 41pc from its peak in 2007 and once again dipped below the 3,500 level.
As the traders and investors return from their summer break it looks likely to be a lively autumn.

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