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Last week, I wrote that the Wall Street consensus idea — that markets would just keep trading in a range — was a “crock of you-know-what.” I also said, “I believe the market could be on the verge of a very large break … and my suspicion is that it’ll be to the downside.”
Boy did that ever pan out! Exactly one trading day later, the Dow Industrials plunged almost 1,100 points before recovering somewhat. Then it dropped again amid a volatility explosion, before trying to launch a deeply oversold bounce.
Many traditional analysts and CNBC pundits are running around trying to grasp for explanations. They’re blaming everything from computer trading algorithms to investors who just don’t understand their worldview that everything is peachy.
Hogwash! This crisis is completely understandable. It’s the result of all the forces I’ve been discussing with you for months on end — weakening economic growth at home, massive turmoil in China and other emerging markets, breakdowns in multiple U.S. market sectors, and huge warning flags coming from the bond market.
But one factor I haven’t talked about YET — but need to share with you now — is the implosion of massive, global “carry trades.” In simple terms, a carry trade is when you borrow money from one cheap, low-rate source of funds and invest that money in a more expensive, higher-rate asset. Your profit is the difference in what your funds cost to borrow and what you earn from your investment.
The $5.3 trillion currency market is famous for this. Investors worldwide are constantly borrowing in the cheapest currencies they can find, and investing those funds in higher-yielding ones. They use massive amounts of leverage to increase their returns. And they count on making money from both moves in underlying currencies, and the increasing value of the assets they buy with their borrowed money.
But those trades are now, to put it in layman’s terms, “blowing up!”
The non-stop devaluation in carry trade currencies like the Japanese yen, Swiss franc, and euro is starting to reverse. That’s causing losses on the borrowing end of the carry trade. Plus, the currencies, stocks, and bonds they invested in — oftentimes higher-yielding emerging market assets — are all plunging. That’s causing losses on the investing leg of the carry trade.
In other words, they’re losing money coming and going. Just look at this long-term chart from a Bloomberg story earlier this week. It shows the performance of a Deutsche Bank index that tracks carry trade profitability …
You can see that imploding carry trades helped cause the market meltdown in 2007-08. And you can see that this carry trade index is now rapidly falling, dropping back toward the levels we hit during the depths of that meltdown.
That is yet another reason — as if we needed one — that stocks could be living on borrowed time. After all, the Dow Jones Industrial Average was trading for around 10,000 the last time this index was trading at these levels.
Bottom line: If you haven’t already cut your stock exposure, raised cash, grabbed gains and cut losers, please don’t wait much longer. Take advantage of oversold rallies to lighten up.
I also urge you to start looking at strategies that haven’t really worked for the last six-and-a-half-years, but that are starting to crank now. I’m talking about using inverse and leveraged ETFs, put options, and other plays on increased volatility, falling asset prices, and declines in vulnerable, lousy-rated or risky stocks. They are all vehicles that can help you profit as global carry trades implode.
Indeed, my Interest Rate Speculator service has already been hitting the ball out of the park. And I think we could be just getting started given this latest carry trade catalyst.
Until next time,
Mike Larson
Mike Larson graduated from Boston University with a B.S. degree in Journalism and a B.A. degree in English in 1998, and went to work for Bankrate.com. There, he learned the mortgage and interest rates markets inside and out. Mike then joined Weiss Research in 2001. He is the editor of Safe Money Report. He is often quoted by the Washington Post, Reuters, Dow Jones Newswires, Orlando Sentinel, Palm Beach Post and Sun-Sentinel, and he has appeared on CNN, Bloomberg Television and CNBC.
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I like your advice on switching strategies towards things that have not been profitable of late. It paid to switch to commodities in 2009 and, while it may be a bit early, it may not be a bad idea to start accumulating the metals that have been beaten down.
Keep up the good work!
I’m getting confused…
Mike Burnick showed charts that say ‘historically’ the depth of equities being oversold is usually followed by a strong rally over the next month and over the next 12 months.
Not sure who to listen to, but I have been following Mike (Larson) for about 8 years and found he knows his stuff.
I’m also a little confused. It strikes me that the main “cheap funding” currency since 2009 has been the US dollar, which weakened until late 2011 and didn’t start to significantly strengthen until 2013. The carry trade, at least to EM, worked because their currencies and markets were rising, earning carrying investors a much higher return there than their low funding cost in US$.
Since late 2013, the dollar has gotten a lot stronger, while EM has been fading, and now their currencies have crashed. The big returns have been wiped out. The US$ are heading back to the US, to buy assets here presumably. (Although I think it will mainly be buying real estate and bonds — I disagree with some of the M&M analysis here.) Those who borrowed in US$, even without a hike in US short rates, have to pay back more to translate their (declining) EM returns into strengthening dollars.
The euro and yen will resume their long-term declines relative to the dollar, as those economies are toast. The action here, with “carry,” though, is mainly about EM, not developed markets.
John S.: “I’m getting confused…
Mike Burnick showed charts that say ‘historically’ the depth of equities being oversold is usually followed by a strong rally over the next month and over the next 12 months.”
I agree with you. It depends on who you’re listening to as to whether you think the markets are in rally mode or due to tank further…..and opinions seem to vary widely.
Thing is, on the one hand, we are currently in an environment much like 1998-1999…at the end of an 8 year democratic presidency, low oil prices, sell off in gold & other pms, high stock market averages…all that’s missing is Greenspan’s “irrational exuberance” speech.
On the other hand, the environment is also much like the sub-prime mess of 2007-2008, wherein the recent events in Greece could be today’s equivalent of the Lehman Bros. bankruptcy. It seems the entire world now has it’s own version of a HUGE sub-prime crisis!!
What I’m trying to do is:
1) STAY ALERT
2) Be NIMBLE (This is NOT a buy-and-hold kind of situation!)
and 3) DON’T get too GREEDY!!!
For what it’s worth, I have found the following ETFs to be good ways to play the ups and downs for the “simple” investor/trader such as myself:
UPRO, UDOW, TNA, DGP, NUGT, JNUG
-versus-
SPXU, DXD, TZA, DZZ, DUST, JDST
Also, if anyone hasn’t found it yet,
Go to Bigcharts.com
Click onto the “Advanced” chart button at the top
On the left, set one “lower indicator” on MACD
and a second one on RSI
You may, at times, also want to set the upper indicator on Bollinger Bands
You can use these settings with any time frame of any stock or etf you’d like to examine.
The “six months, daily” setting is a very insightful period time to look at, esp. with MACD.
I have found this to be extremely helpful…maybe it’ll help some of you.
I can’t wait for Larrys Friday afternoon edition. Always very interesting reading about the sovereign debt crisis in Greece and what’s next gonna happen to the euro zone currency.