The Four-Letter Word That Sent Stocks on a Wild Ride
RJ Hamster
The Four-Letter Word That Sent Stocks on a Wild Ride
Debt.
Almost everyone — from the richest in the world to new college grads — are already drowning it. And the deep end keeps getting deeper.
As this wave of debt rolls across the U.S. economy… it’s making its mark in some surprising ways. Ways we can use to position our stock portfolio and stay on the right side of this trend.
When we hear “debt,” we mostly think of loans and lines of credit. But let’s not forget about margin debt — the money folks borrow for investing and trading.
Because margin debt — Wall Streeters call it “leverage” — is very much on the rise. As stock prices rebounded this year, so did fund managers’ use of leverage in their clients’ accounts:
Source: FINRA
Hedge funds are notorious leverage addicts. Trading on credit is a great way for them to play the catch-up game when their returns are lagging. And with stock indexes up 20%-30% off their bear-market lows, that’s exactly the game hedge funds feel pressured to play lately.
And that pressure shows up in that chart above as a nearly 13% increase in margin debt heading into second-quarter earnings season.
Earnings season was when the game got interesting for the hedge funds. And by “interesting,” I mean “forced to make big moves.”
I believe this leverage wave is triggering the extreme reactions we’ve been seeing in stocks of late when the underlying company surprises on earnings — to the upside and downside.
Paycom Software (PAYC), Expedia (EXPE) and Fortinet (FTNT) all plunged on reports that weren’t that bad. All three of them turned in earnings beats, actually. But the companies also committed that cardinal sin: Their forward guidance fell short.
However, if you held the right stocks through earnings season — you were rewarded with market-beating gains, instead. Meta (META), for one, jumped on its earnings report after CEO Mark Zuckerberg reined in his spending and made his first $10 billion on Instagram Reels.
Arista Networks (ANET) is another tech company whose shares rocketed higher on earnings. This was one of my picks for Quantum Edge Trader a couple weeks prior to its own earnings report, when my system detected that bullish momentum was building in the stock — and spotted signals that ANET’s quarterly numbers would give investors a nice surprise.
But, again, when a company doesn’t have what it takes to save the hedge fund’s bacon, they’ll dump the shares.
If they’re holding those shares on margin, they’ll have to.
Those hedgies will get that unwelcome call from their broker: “Liquidate some positions today, or we’ll do it for you.” And that’s when things get dicey for the stock.
That’s why you have to be especially careful to own only the select few, highest quality stocks right now.
In this market, we’ve got the usual volatility that tends to happen in August and September — and it’s only amplified by all that hedge-fund margin debt. So, don’t sit there holding anything less than the best.
With Nvidia’s dominance in AI, its trailblazing technology, and the escalating demand for AI applications it makes a robust candidate for continued growth.
But if you feel like you missed out on Nvidia’s meteoric rise, and you don’t want to wait around for a pullback, there are smaller players out there ready to breakout…
And That’s Not the Only Way Debt is Impacting Stock Opportunities Now
Hedge funds aren’t the only players binging on debt. Consumers have, too.
Here’s another fun fact for you. And I use the term “fun” loosely, of course:
Did you hear that credit card debt just topped $1 trillion for the first time? Sooner or later, this uptick in debt was inevitable – especially as the worst inflation in four decades caused the price of everything to just keep climbing. People can cut back on some wares and some services — but not on the “must-have” items American households see as basic needs And so, this “non-discretionary spending,” as an economist would call it, might wind up on the credit card, too. Where else are folks going to turn to make a purchase — instantly — no matter what?
The catch, of course…for the customer, anyway…is that you’ve got to pay for that convenience.
Credit card companies can now nail consumers with interest rates of 20%, even 21%.
That’s a steep climb from 15%–16%, which is what those issuers were averaging in 2018 and well into 2022, looking back at the consumer credit data from the Fed.
This is quite a windfall for Visa (V), Mastercard (MA) and friends.
Visa, for one, is pulling in a profit margin of 49.9%. Earnings are up 13.8% this year on 21.6% sales growth; not bad for a $490 billion company.
And the party can (and probably will) last longer than you think.
Sure, rates won’t stay high forever. I fully expect the Fed to quit raising rates soon — and to reverse course and start paring borrowing costs.
But for Mastercard, Visa and their brethren, the real profit margin is made with balances.
Let’s say the Fed dials it back, and credit-card companies start charging 18% instead of 20%. Even 18% on $1 trillion of consumer debt still gets them $180 billion gross, every year. Breathtaking.
Until the day comes when a miraculous amount of consumer debt gets repaid, credit cards will remain a great business.
And that’s exactly what they are: great.
Balances aren’t the only source of revenue for these guys, after all. You can’t forget about “processing fees.”
Visa, Mastercard, Discover (DFS), American Express (AXP) and others … they all collect fees from the businesses that accept their cards. Think of it as a kind of “toll” the card companies exact from stores, e-commerce sites and services that use their payment networks.
The bottom line: While most folks will get dragged under by the debt wave, credit-card issuers surf on it. It’s a great business model for what we’re watching. Right now, in my Quantum Edge system, Mastercard is the stock that scores the highest. Not only does it have solid stock momentum, with a Technical Score of 64.71, Mastercard definitely has the best Fundamental Score of the bunch, at 75.02.
Credit-card stocks tend to have high institutional ownership, and MA has had six Big Money buy signals in the past six months, with zero Big Money sells:
Although it’s not always the first to come to mind. At least, not for most investors. But they don’t have an algorithm out there combing through all 6,000 stocks, day after day, for the absolute best opportunities.
Disclosure: On the date of publication, Jason Bodner held a position in Expedia (EXPE), Fortinet (FTNT), Mastercard Inc. (MA), Paycom Software (PAYC) and Visa Inc. (V), mentioned in this article
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