You Got To Know When To Hold ‘Em, Know When To Fold ‘Em. The Gambler
Songwriter Don Schlitz wrote those lyrics back in 1978 as part of his song called The Gambler, but Kenny Rogers made it famous when he recorded the song. Given today’s stock market, I couldn’t think of a better description.
Inside, we’ll look at the trend in margin debt, supply and demand, upcoming seasonality, a quick reminder on Roth IRA catch-up contributions and just how hard it is to pick stocks. Read on.
Leverage Can Amplify Gains, And Also Destroy You
Margin debt for the U.S. stock market recently set a record level at $1.5 trillion and is also at a record high of 4.7% of GDP (Gross Domestic Product), according to Ned Davis Research. Conventional leverage in the stock market has typically been limited to using margin in a brokerage account, where you can borrow up to 50% of the value of your holdings (2 to 1 leverage).
With the invention of leveraged long ETFs (exchange traded funds), there are now products that deliver gains and losses as much as 3 to 4 times the moves of stock indexes and individual stocks. And those numbers can be far exceeded with the use of derivatives (futures and options).
Perhaps the biggest blow up in the history of Wall Street was the collapse in 1998 of Long Term Capital Management, founded by several Nobel Prize winning economists who were so confident of their mathematical formulas, they levered their balance sheet by a factor of about 25 to 1. On my bookshelf and my to-do-list is Roger Lowenstein’s tale of their demise, When Genius Failed, which was published back in 2011.
Below is the most recent chart of margin debt with data going back to 1970, courtesy of our friends at Ned Davis Research (www.ndr.com).
As I’ve circled on the bottom clip, whenever the 15-month Rate of Change has exceeded about 50-60%, this has typically been associated with poor times to be associated with stocks. The examples above include 1972, 1977, 1984, 1998, 2000, 2007 and 2021.
Objectively, not every situation turned into a horrible outcome. Stocks lost about -7% in 1977, and actually gained about 6% in 1984. The year 1998 was marked by a substantial drop in September and October, but still closed the year with double-digit gains. However, 1972, 2000, 2007 and 2021 all foreshadowed bear markets with subsequent losses ranging from about -25% to nearly -60%. Here we are again in 2026 with similar warning signals.
With markets rising over time, it is fair to ask and compare what is the level of margin debt as a percentage of market cap, and ironically, that sits about its long-term median of about 2.2 to 2.3. The main concern is the sharp acceleration in the velocity of debt, showing up in the chart as excessive speculation.
At some point, the psychology becomes so ingrained in many investors that the stock market is “easy money” and leverage becomes more and more rampant. At some point, these investors are going to find out otherwise, but I certainly can’t tell you when. It just feels like NOW, with the substantial increase in supply coming to market (see below) and the rampant speculation in AI (artificial intelligence) related stocks.
We’re About To Learn About Supply & Demand
In last month’s update, we highlighted the initial public offering of SpaceX and its astronomical (pun intended) valuation of some 94 times revenue (the company is currently not profitable). They are likely the poster child of the craziness of the IPO frenzy, as illustrated in the chart below, courtesy of John Hussman and www.hussmanfunds.com.
This data goes back 36 years, and according to Hussman, the valuation of companies going public this year are likely to enter the stock market at levels which are twice the previous records of 1999 and 2021. If you recall, those were years preceding significant declines. We’d mentioned last month that past historical data on initial public offerings showed a high probability that an investor need not be in on the offering to grab stock at a company’s IPO with nearly 70% of new offerings trading below their initial price within 12 months. Little did we know it would not take 12 months for that opportunity. See the chart below.
The stock’s IPO price was $135. It closed the first day at 160.90, and then two days later rocketed to $201.80. Since then, it’s down (-44%), and you can buy it (-17%) below the $135 offering price. Since we’re talking about supply and demand, the company will hold its first-ever earnings call on August 4 and on August 6, there is a lock-up expiration for insiders that will add up to 911 million shares to the market. The company is not profitable, and at current prices and revenue estimates of around $19 billion annually, SPCX is trading at around 79 times revenue (sales). For perspective, take a look at the price-to-revenue ratios of the Magnificent 7 companies, based on data provided by www.investech.com.
Nvidia (NVDA) 19.8
Tesla (TSLA) 15.5
Apple (AAPL) 9.7
Microsoft (MSFT) 9.2
Meta (META) 6.1
Alphabet (GOOG) 5.1
Amazon (AMZN) 3.6
Clearly, there is a lot of fluff in Space X at present, but soon, the company is going to have to start delivering profits. It should be noted that Meta (then known as Facebook) also had a very rough start as a public company, back in May of 2012, closing at $38 its first day. By September, the stock was below $18, down more than (-50%). And then, it was off to the races. Will history repeat? Given the speculation in stocks and the length of this bull market, it would not surprise me to see Space X trading below $70 per share in the next 12 months. Meta went public (as it turned out with hindsight) at the beginning of a long-term bull market that arguably is still going on, but Space X has gone public at what may turn out to be the top, given the record supply of stock and excessive speculation.
We are beginning to see weakness in the high yield bond market, but 3 of our 5 stock market risk models are still positive, so though it is not likely time to run, it definitely is time to start folding ’em.”
3rd Quarter Seasonality
As I write this with 4 trading days left in July, the S&P 500 Index is down -1.5% for the month, small stocks as measured by the S&P 600 (IJR) are down -2.31%, while the Nasdaq 100, dominated by technology stocks is down -8% and emerging markets (IEMG) are off -7.50%. This is certainly bucking the historical trend for the month of July, as shown below in data courtesy of CFRA and lowryondemand.com.
Seasonals are simply probabilities based on past data, and we don’t trade on them, but they can be useful when they line up with market action. We’re about to enter the two worst months of the year, and that is illustrated below with the four-year cycle chart from Ned Davis Research.
Weakness is expected through September, followed by a year-end rally. If only it were that easy.
The Roth 401 (k) Catch-Up Twist
The annual contribution limit for 401 (k) plans for 2026 is $24,500, plus an additional $8,000 “catch-up” contribution, unless you are 60 to 63, in which case the “catch-up” is $11,250. But, for the first time, for participants with more than $150,000 of prior-year FICA wages, the catch-up portion must go into a Roth 401 (k), meaning it will be after-tax dollars. Most 401 (k) plans already offer Roth 401 (k) accounts, but it would behoove you to find out for sure, and to confirm with your employer that any catch-up contributions will automatically be put into the Roth portion.
You should be able to discern this by examining your recent pay stub. If you happen to be in this situation and find out that the catch-up contributions are still going to your pre-tax account, your employer needs to fix this to be in compliance with IRS rules. One other note. If you’re self-employed or a partner without W-2 wages (like myself and Steve Medland), these restrictions do not affect you, meaning that the catch-up contributions can continue to be deducted pre-tax.
Picking Stocks Is Hard
In the 1980s, Peter Lynch became famous for his track record of managing the Fidelity Magellan fund, and he retired from managing the fund in 1990 at the age of 46. In 1989, he published a book, One Up On Wall Street, espousing his strategy of “investing in what you know,” though it’s a lot more complicated than that. He emphasized using your daily life, personal experiences with products and common sense to find great companies before they are recognized by Wall Street. Then you have to do the financial research.
This isn’t quite the Peter Lynch test, but we did a mini-version of this with our daughter Caroline starting back in early 2023, just to get her feet wet into this process. Inside of her college fund brokerage account, I had her pick 4 companies she was familiar with and used their products and we invested about $500 each in them back on February 13, 2023. We happened to do a review of these recently over a pancake breakfast, so I thought to use the results to make a point. She picked Apple, Disney, McDonalds and Starbucks, certainly companies that most teenagers can relate to and many use their products (a Disneyland Pass in Caroline’s case, though no more). The results thus far are summarized below.
Stock Value 2-13-23 Value 7-24-26 % Change (compounded annually)
Apple $462 $1014 25.6%
Disney $540 $489 -2.8%
McDonald’s $532 $574 2.2%
Starbucks $543 $559 0.8%
S&P 500 4137 7412 19.9%
Though the purchases were not exactly equal-weighted, the average gain of the 4 stocks was 6.45% compounded versus nearly a 20% per annum pace for the S&P 500. All of the heavy lifting was from one stock, Apple. Ironically, this bears out research that shows that over the long-term of the stock market, only about 4% of all stocks have accounted for all the gains since 1926. Despite this, I doubt it will dissuade many investors from picking stocks. It’s in the nature of humans to want to do better, regardless of what the research says. And I would take an educated guess that most investors do not do the research that Lynch refers to.
Our suggestion would be for those that have an interest in this area is to do this with a small portion of your overall portfolio, and preferably, have a process. Don’t just shoot from your hip. It’s quite hard to beat the S&P 500 picking stocks, as evidenced by the large majority of large cap fund managers who trail the index. We’re even running a strategy that is attempting to do this, now with over 6 years of real-time data, in what we call our S&P 500 Relative Strength account. So far, it has created an edge, and we’ll see if that continues, but you have to have the discipline to run the strategy consistently and put up with a lot of volatility, both up and down. Even with processes that “work,” just remember that picking individual stocks is hard.
Material Of A Less Serious Nature
Once there was a little boy who lived in the country. They had to use an outhouse, and the little boy hated it because it was hot in the summer, cold in the winter and stank all the time.
The outhouse was sitting on the bank of a creek and the boy determined that one day he would push the outhouse into the creek.
One day after a spring rain, the creek was swollen so the little boy decided today was the day to push the outhouse into the creek.
So, he got a large stick and started pushing. Finally, the outhouse toppled into the creek and floated away.
That night, his Dad told him they were going to the woodshed after supper. Knowing that meant a spanking, the little boy asked why?
The dad replied, “Someone pushed the outhouse into the creek today. It was you, wasn’t it son?” The boy answered yes.
Then, he thought a moment and said, “Dad, I read in school today that George Washington chopped down a cherry tree and didn’t get into trouble because he told the truth.”
The dad replied, “Well, son, George Washington’s father wasn’t in that cherry tree.”
Since I root for at present the two worst teams in baseball in the Angels and Giants, I’m almost in full football mode (other than Tanner Bibee’s Cleveland Guardians!). And sure enough, my 49ers are already in mid-season mode, with head coach Kyle Shanahan out with a concussion, 40 stitches, 3 broken ribs and a broken hand. My teams can’t catch a break (pun intended). Speaking of a break, hopefully the temperatures in Southern California will give us all a break from the recent heat wave, but hey, that’s what summer is all about, whether it be in So Cal, NY, Texas or elsewhere. As always, thank you for your trust and confidence in all of us at TABR, and allowing us to serve you.
Sincerely,
Bob Kargenian, CMT
President
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