Traders came back from the Labor Day weekend with selling on their minds…
As you surely know, the markets took a big hit last week. From its Friday, August 30 close before the long weekend to this past Friday’s close, the S&P 500 Index fell more than 4%.
Sure, September is historically the cruelest month for stocks. But that weakness historically surfaces in the latter half of the month.
So… what happened last week?
Well, profit-taking in the increasingly vulnerable tech sector combined with weaker-than-expected reports from the manufacturing side of the U.S. economy put traders on the defensive.
Friday’s mixed August employment numbers included downward revisions to the robust June and July job growth numbers. Then everyone hopped on the “recession is imminent, and the Federal Reserve is behind the curve” bandwagon.
What was once a welcome 25-basis-point (“bps”) interest-rate cut at the Fed’s upcoming meeting next week is now feared to be a more dramatic 50-bps cut.
Yes, lower interest rates are good for the debt-laden consumer and the all-important homebuilding industry. However, as always, other forces are at work…
In this case, it’s the continued unwinding of the Japanese “yen carry trade.”
For some context, my colleague Pete Carmasino recently discussed the situation in this month’s edition of his Chaikin PowerTactics newsletter. As he noted regarding the big market turmoil on August 5…
That was the largest sell-off in two years. The Nasdaq Composite Index plummeted 3.4%, the S&P 500 dropped about 3%, and the Dow fell 2.6%.
But remember that this came on the heels of the Japanese market dropping an eye-popping 12% in just one day. That was due to what’s known as the “yen carry trade” unexpectedly starting to become unwound.
Pete also described how the trade worked…
To briefly explain the yen carry trade, institutions were borrowing money in Japanese yen at an interest rate of almost zero. They were taking the proceeds from the loan and then making investments that paid well over their borrowing rate.
Folks call it the “carry trade” because to do the trade, you must “carry” the debt. In other words, it means going into debt. By doing this trade, the yen was falling in value. And since the U.S. was paying the most interest with the best credit rating, the U.S. dollar was rallying.
And as Pete continued…
To stop its currency from falling, Japan had to raise interest rates. When it abruptly did so, the trade reversed. U.S. assets and other global assets were sold in order to pay off the loan in the yen, and the yen increased in value.
It happened so fast that the markets got walloped. But in Japan, the next trading day after that 12% fall, the country’s market rallied about 10%.
Looking ahead, a 50-bps rate cut here in the U.S. next week would put further upward pressure on the Japanese yen. Traders have borrowed the weaker yen at low interest rates to buy U.S. technology stocks like the so-called “Magnificent Seven” mega caps.
The first unwinding of those positions caused the early August tech wreck. And last week, we saw more of the same.
The good news of potential interest-rate relief for the U.S. consumer quickly turned into the bad news of a sharp sell-off in the over-owned technology sector.
That sell-off pushed CNN’s Fear & Greed sentiment indicator back into “Fear” territory. This is another sign that emotions have taken over from fundamentals.
However, I had expected the markets to be choppy and volatile to the downside in September… leading to a robust post-election rally.
The damage in the other 493 stocks in the S&P 500 – as measured by the equal-weighted Invesco S&P 500 Equal Weight Fund (RSP) – has been much milder.
I remain “bullish” on stocks overall. And I see these selling squalls as buying opportunities for stocks with “bullish” Power Gauge ratings.
I’ll repeat what I said last month…
Looking ahead, I expect typical September volatility and overly dramatic election-year headlines to wreak havoc with investor’s emotions…
But my conviction in a post-election rally remains firm.
And I continue to expect a rally in the S&P 500 to the 5,800-to-6,000 level by the end of the year.
Good investing,
Marc Chaikin
