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Which bubble is your bubble?


All these points and counterpoints twist my noggin'


It occurs to me that among all the talk about an equities bubble, everyone seems to assume the bubble only works one way - that stocks are dangerously overvalued. As with all things Minxy, there is another side.

The chart below shows the growth in short interest compared to the growth in composite indexes for both the NYSE and NASDAQ. All series are indexed to January 2003 (that month equals 1.00), a couple of months before the current bull market is generally accepted to have begun.

Market values are rising, but short interest has been rising as well. Every high point on the short interest chart lines above represents an all-time record high short interest level.

Short interest data are problematic. They really represent a snapshot taken on one day. They are reported only once per month. We know nothing about the motivations behind these positions. The data do not include short positions in options - at least not explicitly. Some believe a more valid measure of short interest is as a percentage of trading volume, but I don't buy that since you don't cover a short gone bad with a percentage.

Nevertheless, eyeing a chart like this once in a while seems instructive to me. While NYSE short interest has generally declined as stock prices rose, NASDAQ short interest has done nothing of the sort. It has generally risen along with rising NASDAQ prices, which begs the question:

Exactly how long can the short side keep absorbing these losses? At what point does their bubble burst?

With the gains we've seen in these indices, it may seem foolish to chat about a bubble on the short side. While Hoofy has had the measure of the Minx for some time, Boo has captured the hearts of many of my fellow Minyans. Each day we read another take on why the market is headed for collapse. I humbly offer this, as my father used to say, as a 'Yeahbut' to the conventional wisdom.

Only a fool would deny serious problems exist that could dramatically and adversely affect equities and "burst their bubble." Such worries are a constant. What is equally foolish, to my mind, is to ignore items like sustained record-high short interest in a rising market. A bursting of the short-side bubble could result in rapid and significant upside moves. One cannot count on such things happening as the short-side crowd has been remarkably patient, seemingly possessing infinite resources to add to a position that has (on average) been going away from them for fifteen months.

Food for thought...

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No positions in stocks mentioned.

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