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The breathtaking run-up in stocks this year has corresponded with an even more dramatic increase in margin debt, and that -- along with an increasingly unskeptical market that recently welcomed several iffy new issues -- could bode ill for the rally's sustainability.

While the

S&P 500

and

Nasdaq

aren't trading at the sky-high valuations they were during the peak of March 2000, they're still well above their historical averages. And individual stocks have zoomed ahead on little more than a hope and a prayer.

Avaya

(AV)

, for example, has surged 358% since the start of the year, while

MGI Pharma

( MOGN) is up 454% so far, even though neither firm is expected to post a profit in 2003. MGI isn't expected to turn a profit next year either.

At the same time, perhaps not coincidentally, individual investors have been borrowing money to buy stock at a disturbing pace. Margin debt at brokerage firms registered with the NASD surged to $26 billion through July 2003 from just $7.3 billion at the end of May and $5.1 billion at the end of 2002.

Margin debt at Nasdaq member firms now accounts for 15% of total margin debt compared to just 7.1% at the peak of the market bubble three years ago. "The bubble is alive and well at online traders," said Charles Biderman, president of Trim Tabs Investment Research.

Back in 2000, sharp declines in the stock market prompted margin calls from brokerages, which forced investors to repay the money they had borrowed. That created even more selling in the market.

Biderman said he is also concerned about the level of insider selling, which was very high in August. In addition, there's simply too much supply coming into the market in the form of IPOs and follow-on offerings, and there isn't enough demand to sop it up, he said.

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The quality of some of that supply has been less than spectacular this week. The biggest tech IPO of the year started trading Wednesday when

AMIS Holdings

(AMIS)

sold $600 million worth of common stock so it could buy out a big series of preferred. The company isn't profitable and insiders unloaded an extra $100 million via a simultaneous secondary.

On Thursday, an outfit called

RedEnvelope

( REDE) raised $30 million through a Hambrecht-organized Dutch auction. The online gift outlet hasn't turned a profit since its founding in 1997 under the unfortunate moniker of 911gifts.com.

Another worrying sign is the recent decline in short interest on both the

New York Stock Exchange

and Nasdaq. Short interest is the number of shares sold but not yet repurchased. The fact that fewer people have been shorting the market suggests that investors are increasingly optimistic about the direction of stocks. In the past, when investors became overly optimistic, it was time to get out.

Richard Bernstein, chief quantitative strategist at Merrill Lynch, pointed to work by Nobel Prize winner Vernon Smith as evidence that stocks could be in for a sharp decline.

Smith, who won the prestigious award in economics last year, has shown that new market participants create bubbles and crashes over and over again. Even though investors were aware of the consequences in the first round of trading, they still participated in a second round because they believed they could make money and get out in time to avoid losses. "Sound familiar?" Bernstein asked.

There are fundamental reasons to expect weakness ahead, too. Oil prices are likely to rise going forward, as the Organization of Petroleum Exporting Countries has said it will cut production. Rising oil prices act as a tax on the consumer.

In addition, the dollar is on a downward trajectory now that the Group of Seven industrialized nations has called on China and Japan to let market forces determine the exchange rates. A slide in the dollar is good for earnings, but can prompt foreigners to slow down their purchases of U.S. stocks and bonds.

Carlos Asilis, fund manager at Vega Asset Management, said these latest developments make stocks even riskier to own. "It's reasonable to assume that these shocks should translate to a higher equity risk premium and therefore a drop in equity prices," he said.

So far, investors have been complacent about bad news, perhaps because they expect stocks to rally when corporate America releases third-quarter earnings. But tax-loss selling by individuals and by mutual funds, whose fiscal year ends on Oct. 31, could lead to a disappointing October, some say. "I think the Nasdaq 100 and a lot of the speculative stocks that are up multiple times are in for a significant correction," said Biderman.