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Stop the Margin Debt Madness

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When debt begins to contract, and we don't see investors putting their substantial cash balances to work by buying more stock, then we need to worry.

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This is a plea to anyone wishing to write another doomsday piece on margin debt.

Before you do so, can you please address the other side of the margin debt statistics? Pretty please, with sugar on top?

Yet another article on the subject was published, and while this was one of the very, very rare pieces that didn't use the rise in margin debt as an excuse to predict the end of the world, it still left out an extremely important fact.

I wrote about this not too long ago, so I'm not going to rehash all the points about why margin debt, as it is almost universally quoted, is useless. But I do want to touch on the other piece of the margin report that the exchanges release.

Bears like to point out the margin debt stats because it gives the suggestion that investors are tapped out – they are so indebted that there is no more buying power.

Well, let's just move our eyes about two inches to the right on that very same report and look at free cash balances.

In March 2000, margin debt was $279 billion. Today, margin debt is $296 billion. Close enough for gov't work, and thus the cries of imminent demise.

In March 2000, cash sitting in "cash" accounts was $85 billion and cash sitting in "margin" accounts was $65 billion. Given margin rules, investors can buy up to twice as much as the free credit balance in their margin account, so…

Buying power in March 2000 = $85 billion + ($65 billion x 2) = $215 billion

Now let's look at today's figures:

Buying power as of February 2007 = $97 billion + ($155 billion x 2) = $407 billion

So in 2000, investors had $279 billion in existing debt, and $215 billion in potential additional buying power.

Today, they have about the same debt, but nearly twice as much available buying power. In fact, I'm being overly conservative here. A good number of these accounts are likely tagged as pattern day trading accounts, meaning that their available buying power is several times greater than the minimum. Given that, it would be safe to guesstimate that the amount of buying power available in these accounts is more than $500 billion, potentially much more.

This isn't bullish or bearish all on its own – just because the buying power is there doesn't mean they're going to use it. So we have to continue to see investors becoming more and more bullish in order for them to put money to work, causing prices to rise even further.

Don't buy into the hype surrounding margin debt. It's been used as a crutch for the bearish argument for several years now, and trying to predict the market looking at only margin debt and not cash balances is like trying to ride a bike uphill with only one leg.

When debt begins to contract, and we don't see investors putting their substantial cash balances to work by buying more stock, then we need to worry.

No positions in stocks mentioned.

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