Record Margin Debt, A Low VIX, & Lower Short Selling: An Investor’s Nirvana?

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Yesterday I was checking some emails from my Palm Treo phone when I noticed an email that rung a sounding bell in my head.  This was an Associates Press article showing that margin debt in January has reached a record $285.6 Billion on the New York Stock Exchange (up 3.7% from December).  It also reminded me of Bob Pisani briefly discussing this on CNBC from the NYSE floor on Friday.  This went on to show that with so many stocks being owned on margin that any major sell-off in the market could have the sales and losses greatly exacerbated because of the forced selling that would occur.  It further goes on to show that the March 2000 peak of the dot.com bubble and before the market meltdown showed NYSE margin debt at $278.5 Billion.

Of course there is a caveat that this means a high level of bullishness on Wall Street with expectations for the markets to continue higher.  Excessive margin debt levels cannot be used as the only doomsday predictor out there.

The WSJ noted For the monthly period ending Feb. 15, the number of short-sellingpositions not yet closed out at NYSE — so-called short interest –declined 0.9% to 9,595,242,421 shares from 9,680,953,526 shares inmid-January.

I would like to add in that the CBOE Volatility Index (the ‘VIX’) is currently down to 10.58, and since the start of January the reading has an average closing price based upon 36 trading sessions of 10.77.  The VIX is often referred to as the ‘fear index’ and this reading shows that there is very little or no fear.  Just 5 trading days ago the VIX was back at 10.0.

A normal reading over the last 3 years before the recent bull run wouldbe roughly around 14.0 to 15.0, but only on September 7, 2006 did itreach 14.49 and you really have to back into August 2006 and priormonths before you can find it running at 14.0 and above 15.0 on aregular basis.  To show an example of this the Dow Jones IndustrialAverage closed at 11,381.15 on August 31, 2006.  It closed Friday at12,647.48.  The VIX usually has to reach readings of 20.0 before youget technicians out monitoring the VIX to say that the market isreaching a selling climax or inflection point.  Please bare in mindthat that is very subjective and that in today’s lower and lower VIXreadings that the threshold may no longer be the same.

The VIXis much harder to use as reading to determine an ‘overbought reading’in the stock market, but it is used as a guide for selling climaxreadings when it starts getting higher and higher.  When you combinethe extremely low VIX reading along with the record margin borrowing itsure sounds like it would give the perma-bears and those who areexpecting major corrections some good ammunition to bolster their case.

Ifyou look at the charts below, all of this is happening at a time whenthe markets are still strong but not in massive Bull Market mode.  TheDJIA closed up less than 2% for the year, the NASDAQ is up roughly 4%,and the S&P is barely up 2%.

               FEB 23        DEC 29
DJIA        12,647.48    12,463.15
NASDAQ    2,515.10    2,415.29
S&P500     1,451.19    1,418.30

Thehidden lining, even in a doomsday and bearish case, is that the low VIXalso translates to very low options prices on a historical basis.  Inshort, you can hedge many of your positions with options to lock-ingains or to protect against major losses.  You can also buy speculativeput options at what would be considered cheaper levels than in the past.

Thelonger-term up-trends in stocks do not show any major overboughtsignals or critical reversal risks on an RSI, MACD, and stochasticreadings.  All of this is happening at a time when the markets are veryclose to highs and at a time when the economy appears to in anengineered soft-landing.  With marging buying higher than ever at atime housing is crumbling and with a very low VIX and a drop in shortselling, one just has to ask if investors are in Nirvana.  You knowwhat a Contrarian would say when everyone else is Bullish.  So youyourself can be cautious and bearish for what will be a very lowhistorical cost in options; OR you can point to the WHY’s about themargin levels being at a record and about the fear index showing almostno fear at all about market prices. 

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.