Yen There, Done That – August 2007

 

Global stock markets sold off violently 2 weeks ago and the SP500 cash index opened Monday August 5^th down another -3%+ to take the index down -9.7% peak to trough over the last 3 weeks. That’s of course if you were a perfect seller and buyer.  The current thumping started on Friday August 2 when markets in America dropped in response to the smaller number of new jobs created in July. The Japanese markets took a tumble on Monday, posting their biggest ever one-day drop in the Nikkei, Japanese equivalent of our S&P500. Since then, markets have moved up and down as investors attempt to understand what is going on. Later last week, the market rallying strongly and ending the week basically spot on flat for the week and -5.75% off its July 15^th closing high.

The cause? According to most financial networks, who were almost uniformly in the hysteria mode that global markets were “crashing” I nan unprecedented way, the blowing up and unwind of the Yen carry trade.  In fact, some so called financial pundits, have attributed the “yen carry trade” as the “primary driver of global markets the last few years.  Investors, this it utter nonsense in my few.

Quickly reviewing what a carry trade is.  Simplistically speaking, a carry trade” is when an investor borrows in a currency with low interest rates, such as the Japanese yen for the last decade+, and then that investor reinvests the proceeds in a currency with a higher rate of return, most recently the example has been Australia.  Japanese Investors and hedge funds had been pyramiding this strategy in recent years, borrowing cheaply in Japan in yen, where interest rates are still low , about zero, and investing in place where rates are higher, such as the United States (5.25%-5.5%) or even higher like Mexico (10.75%). Researchers at UBS estimated that  more than US$500 billion in US dollar-yen carry trades have taken place.

When the trade begins to reverse course, for whatever reason be it interest rate differentials, monetary policy changes, or just the change in the pattern of the squiggly line on the chart, many quantitatively driven funds are forced to reverse course and deleverage their positions.  When too many investors are playing the same trade, this can result in a cascade of selling as we saw in the Japanese markets with the Nikkei being down -12% in a day.  This move down brought out the dormers and hysterical Perma bears calling once again for 1987 like crashes,

Investors, it is not 1987.  Not in the economy.  Not in the markets.  Not in interest rates, not in stock chart patterns.  In fact if it did set up that way, anyone who missed out on the last 3-5 year stock run up and was sitting in cash, or even those who ere all in long, but not on margin or leverage, should be hoping it is 1987?  Why because in 1987 the S&P 500 was up almost 35% into October before falling back to negative YTD territory in a few weeks and finished the year marginally up.  And even after October of 1987, the SP500 went on to gain over 125% over the next 6 years compounding at nearly 20% per year.  Investors, I would love for this to be mid-1987.  It’s not.

Those citing the recent implosion of the yen carry trade in late July and the first week of August either have a very short memory, or don’t know how to do a basic Google search.  It’s not 1987, but unfortunately it could be 2000 or worse 2007  We’ve discussed the similarities numerous times over the last 18 months to the 1998-2000 Dot.com internet buildout, both good and bad.  We’ve also discussed how the Fed is acting in a similar way to 2007 and how some of the data series, such as real time real interest rates set up in a similar was the summer of 2007. During both periods, the Fed was to tight for too long and economic slowdowns morphed into recessions.  Granted these were both pre-QE policy time periods.

Investors, the last Yen carry trade blow up that few investors remember.  Yeap, almost to the day, back in August of 2007.  In fact, here is an expert from the NY Time on August 17^th, 2017.

“The recent volatility in global stock markets has raised the prospect that a distinguishing feature of the financial world for years now, an investing tool known as the “yen carry trade,” may be coming to an end.  The unwinding of carry trades sent the yen soaring Friday to its highest level against the dollar in 14 months as the Nikkei 225 index suffered its worst single-day loss since the Sept. 11, 2001, attacks on the United States. Here’s a link to the full article. https://www.nytimes.com/2007/08/17/business/worldbusiness/17iht-yen.4.7159153.html

Besides the Yen carry trade implosion in August of 2007, what things are reminiscent of that pre-QE time period as well as the summer of 2000?  As we have previously discussed, both the absolute level and now chart configuration of real time real interest rates. Only in the summer of 2000 and the summer of 2007 did 1-year real interest rates exceed 4% as they have recently done.  During both prior periods, the Fed acted too slowly, and recessions transpired over the next 9-15 months.  Here’s a chart of the very long term 5-year real interest rate.  It has clearly formed a head and shoulder pattern as it did in mid 2007.

Looking back at the S&P 500 during these periods the return performance of the July/August periods are early similar to our current pattern since the July 15^th top. In summer of 2007 a July shor4t term peak, and the markets fell about -6.5% over 3 weeks into early August.  In mid July 2007, a short term summer peak at ATH’s, the market fell about -6.5% into early August, and then another -3% on the back of the Yen carry trade blow up scare.  Peak to trough in July/August 2007, the S&P 500 fell about -9.6%.

Here’s what has just transpired in the S&P 500 in July of 2024.  A short-term top on July 15^th at and ATH around 5669.  A quick 2 week drop of about -6.5% into a weekend, then another -3%+ drop on a Monday on the back of yen carry trade blowups to bring the S&P500 down -9.7% peak top trough if you were perfect. Almost identical to August 2007.

So if you are convinced it’s the same play or rerun of either period, is it time to panic?  History would say no.  There is a better selling opportunity coming from higher later in August and maybe all the way into September.  Why, because in both years the lows the first week or two of august were the short term low for the next 3 weeks in the case of 2000

With last week’s rally we now sit almost exactly on a % basis, where we did both August of 2000 and 2007. Down about -6-7% off ATHs.  In both prior cases the markets rallied strongly.  In 2000 almost +8.5% to near previous ATHs into month end August, and in 2007 over 10%+ to marginal new ATHS into September.  Such outcomes if repeated, and that’s a big if, no guarantees, would take the markets back toward 5600 to 5750 over the next 2-10 weeks. Inconceivable to some. Will that happen? I don’t know.  Can it happen?  Sure why not?  The Fed is likely to start talking dovishly into Jackson Hole and throughout much of September into the Fed meeting.  Stock buybacks are now starting to re-engage and with strong employment numbers, 401k contributions and buying kick in on paydays every 2 weeks.  The Fed will look to calm volatility and any exhaling will likely lead to performance anxiety and stock chasing back to the upside now that many leverage players were forced to sell.

Folks, the Fed is too tight. The bond market knew it weeks ago, and the stock market just came to that conclusion over the last few weeks+.  We’ve seen this play before.

Before you panic, remember these were both periods before the Fed found QE, quantitative easing and many other programs they used to dull or delay economic and market downturns. During both these prior periods, the markets did not cascade lower from there in a straight line

Since the July CPI report markets have been volatile and moved down quickly. Historically, we have only seen one significant meltdown around the commencement of a cutting cycle, and that was in 2001. While the previously discussed 2000 and 2007, the cutting cycles did end in recession. They were pre-QE and characterized by a lack of liquidity. Quantitative easing in significant size has been implemented since then, and you know what that has historically done to tame volatility in markets.

So as we’ve messaged for the better part of the last 6 weeks, If over the years you have found yourself reacting emotionally in your portfolio to Presidential elections and their uncertainty, or when volatility is high like it is now, now is the time to step back, take a deep breath, give your advisor a call and talk walk through your long-term financial plan.

If in the past you’ve felt emotional and compelled to sell stocks, when volatility was high, and they were down. Maybe its time to reverse that habit if it hasn’t worked in the past.  Maybe its time to allocate a little more into equities on a pullback?  I don’t know because I don’t personally know you.  But if you have a good relationship with your advisor, and not just an investment account relationship. Get on the phone and give them a call and see what might work for your longer-term financial plan.

If you are uncomfortable with wider range of possible equity outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges and shock absorber “insurance” for a stock portfolio.  Information on this exciting new strategy of ours can be found at OakHarvestFunds.com.

Viewers, for those of you who made it this far, I want to give a shout out to the entire OHFG team as last week, USA TODAY, ranked us as one of the Best Financial Advisory Firms 2024. The award is given to top registered investment advisory (RIA) firms in the United States based on two key criteria:

• Recommendations from individuals from among 25,000 financial advisors, clients, and industry experts
• Growth in Assets under Management (AUM) over 12 months and 5-years, respectively

I personally am looking forward to helping us move up this list over the coming years by taking care of our current and future client base. From the whole team here, thank you and have a great weekend.

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