Mr. P$nk,
Interesting article. Margin debt looks to be similar to short-interest. Market could be coiled-spring, but for bears. Margin calls could snowball.
What is His opinion on the market in general and His short-term outlook?
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NEW YORK (Reuters) - Get ready for anything as the stock market cruises into
the year's final quarter.
Investors continue to display a lack of fear and the "buy on credit"
mania -- the margin debt -- has zoomed to a new high. In fact, an additional
$3 billion was added to Wall Street's charge account last month as investors
borrowed more money to trade stocks.
This week stocks came roaring back, posting their first three-day winning
streak in two months as bruised investors regained their cool after the
market looked like it was headed over a cliff a week earlier on inflation
jitters.
Lately, it has become a way of life on the Street to expect the market to
get hammered and claw back.
But the Federal Reserve has provided some insight into what is behind the
market's incredible ability to recover. It's margin borrowing -- or old
fashion loans -- to trade stocks.
The Fed reported this week that margin debt jumped to a record $179.3
billion in September, up from $176.4 billion in August, breaking the old
high of $178.4 billion just reached in July.
The bottom line: Investors still have a lot of audacity and they have no
fear of buying stocks, despite the red flags flying over Wall Street. The
tremendous buildup in September's margin debt came as the market recovered
in the weeks following a head-spinning drop of 1,000 points in the Dow. The
slide happened after the blue-chip index set a record high of 11,326.04 on
Aug. 25.
"Again, it was the old buy-on-dip game and borrow against your margin
accounts to trade stocks that caused the jump in margin debt," said Raymond
DeVoe Jr., market strategist for Legg Mason Wood Walker.
Is trading on margins risky?
You bet. Ever speed down the highway with your eyes closed and your hands
off the steering wheel?
"They have essentially doubled their bets, bought on the dips and used up
much of their available ammunition," DeVoe said.
If the market makes a sharp U-turn to the downside, dreaded "margin calls"
go out to the customers and the brokerage houses can sell their margined
stocks without notice -- usually at a loss. It can have a domino effect on
the entire stock market.
"It was only in early 1997 that margin debt passed the $100 billion mark,
and prior to the October 1987 crash, in another highly speculative market,
total margin debt was only around $44 billion," DeVoe said.
For more than 20 years the Fed has kept the basic margin requirement at 50
percent. In other words, margined traders have had to cough up 50 percent of
their own money before getting the other 50 percent tranche.
The brokerage houses have the last say in setting margins for their
customers.
The Fed has been in charge of margins since after the 1929 market crash.
Prior to that, margins were strictly determined by the brokerage houses. In
some outrageous cases, they would allow customers to borrow up to 95 percent
of the stocks' values.
Fed Chairman Alan Greenspan, who has been trying to deflate the stock market
for the last 3 years, can lobby to raise margins but there is no guarantee
that a hike would skim some of the speculation from the market.
"The margins were raised to 100 percent in the late 1940s, when the market
looked dangerous," DeVoe said. "Stocks went up further because Wall Street's
attitude back then was that the Fed could not do anything more to dissuade
the market."
Experts say the market is as dangerous as it has ever been. They warn: Don't
get fooled by the market's latest recovery.
"What we're seeing is an initial correction in a bear market," DeVoe said.
"Investors should be aware of the danger of a bear market, which is: at
first there's a very strong, emotional recovery before the bears take over."
Don Hays, investment strategist for First Union Capitals Markets, said that
for the past 4 years, market corrections have been short-lived, running
between two weeks and two months. But this time, Wall Street could be facing
something more serious.
"We expect the next 10 weeks to be fraught with extreme uncertainty, with
the S&P 500 never able to regain its bullish footing," he said.
Stocks are locked in the claws of a bear market, and not just a short-term
correction, he says. Hays' bet: Wall Street could see a waterfall drop in
stocks sometime before the end of this year.
"To me, it's an indisputable fact, even though it has been loosely
camouflaged by those who refuse to see anything but the action of only 20 or
30 stocks," he said.
Indeed, much of the market's strength since this summer has been driven by
gains in a handful of stocks that are components of the Dow and S&P indexes.
"The S&P has now erased the action of the last nine months and that is the
good news," Hays said. "The bad news, of course, comes from looking at the
other 5,000 stocks instead of those 20 or 30 that are carrying the Dow, the
S&P and especially the Nasdaq composite."
Nothing has changed since the Labor Department reported earlier this month
that the Producer Price Index took its biggest leap in 9 years in September
with a jump of 1.1 percent -- which triggered a headlong drop in stocks.
The PPI's inflation has not as yet spilled over into the Consumer Price
Index, with the September numbers up just 0.4 percent. But just you wait,
'Enry 'Iggins.
Economists say it's only a matter of time before the producers pass on their
higher costs to consumers.
Down the road, Wall Street will suddenly wake to see the effect of
September's PPI impact on consumers. Perhaps, the headlines will read "Wall
Street takes a tumble, Part II."
Investors will also have to contend with the scary noises from the man who
wishes to become the nation's chief investment strategist: Fed Chairman
Greenspan.
No one in this country's history has tried so hard to deflate a bull market.
This month, comments by Greenspan that investors should not under-estimate
the risk of owning stocks played a big role in knocking the Dow briefly
below the 10,000 level.
For the last 2 years, Greenspan has viewed the stock market as an overblown
speculative bubble that's just waiting to burst.
"The fact is that Greenspan really can't do much else to deflate the market
bubble than to try to talk it down," DeVoe said.
"Sure, there may be risk in today's stock valuation but I have never heard
of a successful soft landing in the stock market," he said.
The central bank rushed late last year to cut interest rates three times in
part to keep the U.S. economy from being slammed by the economic crises
abroad.
"The cuts were really made to bail out U.S. banks, which were being hurt by
problems overseas," DeVoe said. "But the rate cuts were interpreted by Wall
Street as a signal that the party was still on and Greenspan was not going
to take away the punch bowl."
The rapid-fire rate reductions sent the Dow through the roof, lifting the
world's most closely watched stock gauge to the 10,000 level by April .
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