Up the Stairs, Down the Elevator – the Rout Continues

Over the past weeks and months, I have written repeatedly about the seismic shifts coming in multiple markets.  I have been focused on a wide array of markets, with imminent warnings about the coming sell-offs in tech stocks, interest rates, dollar yen, dollar Swiss, and the surging strength of the yen against the commodity currencies (Aussie, Kiwi, and Canadian dollar). I didn’t know what the trigger would be, and frankly I didn’t care.  I could feel the pressure building, and I knew everything was getting ready to implode.  In my July 16 write-up I warned my readers that “we need to prepare ourselves for volatility levels that will, at a minimum, approach those of the Dot-com levels...”  Many markets were dramatically mispriced, and I was 100% sure we needed to “strap on our seatbelts” and get ready for a wild ride.  

I was certain that volatility levels in stocks were not only unsustainably low, but that the market volatility was getting ready to explode higher.  I was absolutely right about the timing, but I was wrong about the magnitude.  During the Dot-com collapse, the VIX only reached 48.46%.  This morning, the VIX traded up to 65.73%!!  This is often referred to as the “fear index,” so it is safe to say that there is a LOT of fear in the markets right now. 

Yields in the US treasuries have crashed.  They have dropped by more than 22% in the past few months, with more than half of that drop occurring in the past 12 days.  Stocks across Asia have collapsed.  The Nikkei has just posted its largest two-day drop ever.  It is down about 27% in about 3 weeks.  The Korean stock market had its worst day since the Great Financial Crisis as tech stocks there got crushed.  It is the same story all over the world.  Stocks are getting hammered, and bond prices are surging.  

The currencies are likewise having absolutely gigantic moves. One of my strongest views has been forecasting a vicious reversal of what I knew was the yen’s unsustainable weakness. I warned repeatedly that the surge in the yen was going to be massive once it started. Less than two weeks ago, on July 24, I wrote that the reversal  had started, and that the imminent unwinding of positions could easily push the yen to test the 140-yen level, and perhaps break it.  I knew it would be violent, and in less than two weeks, dollar yen has crashed more than 15 yen, testing 141.67 this morning.  My feeling is that the unwinding of the yen carry trade is not nearly done, but we are due for a sharp technical bounce before the next round of yen buying commences.  

Regarding the panic in the stock markets, it was almost inevitable that after a 15% meltdown in the Nasdaq in slightly more than two weeks, the authorities would try to calm investors down by sending out a number of “experts” who will talk about the strong economy and solid fundamentals of US companies.  What the authorities won’t want to discuss is their role in creating the economic distortions that lead to wild market volatility.  

As I have written about repeatedly, the US Federal Debt levels have created a number of economic distortions that are bound to lead to market distortions.  In the past three and a half years, the US has added about eight trillion dollars of debt – and counting!!  Think about that number for a minute – $8,000,000,000,000.00 – that is a seriously large amount of money.  Before the end of the year, that number will be nearly $10,000,000,000.00.  Think about that number even more seriously!! TEN TRILLION DOLLARS!!  

What are the guys in Washington thinking?  Do they really believe this is responsible?

Are they aware of the long-term repercussions of these policies?  Do they care?  These are all serious questions that we need to ask our various elected officials.  

Below are a few daily charts which will put some of these moves in perspective. 

Here is the Nasdaq100

Below is NZD/JPY. Kiwi yen should eventually have a much bigger fall, but it is overdone in the short term. I wrote about this at length last week.

Here is the Australian dollar versus the Swiss franc.  New all-time lows in this cross.  It isn’t over, but like the other markets, it is time for a bounce.

Here is Nvidia.  I actually like this company over the long term, but people need to remember that all markets seek balance.  They need to correct and adjust when things get too far out of line.  It has dropped over 35% -- that is enough for the short term.

Here is dollar yen.  One of my real favorites.  After dropping below 142 this morning, it is finally bouncing a bit. 

I had a good laugh earlier today.  First of all, “serious” bankers were blaming the recent collapse in dollar yen and the Nikkei on the Bank of Japan’s recent hiking of interest rates.  Huh?  Seriously? I thought they were joking, but they insisted that the hike of fifteen basis points caused a global rout in equities, caused bond prices to surge, commodities to get crushed, and dollar yen to effectively crash because it forced the unwinding of the massive yen carry trade.  The fact is that a 15-basis point move didn’t cause this at all.  It was already happening.  People don’t sell trillions of dollars of assets because of a move in interest rates of .15%   As I have written repeatedly, the move had already started.  When markets are ready to move, one excuse is as good as another.  The size of short yen exposures in the market was gargantuan.  It was among the most over-crowded trades I have ever seen. 

Traders decided that borrowing yen at .1% and investing the leveraged proceeds in tech stocks, dollars, and a host of other assets was a “free lunch.” If so, then it would still be a free lunch at .25%.  Well, there are no free lunches out there, so we have had a massive exit through a small door.  I don’t believe the positions have been fully cleaned up yet, but this is enough for now.  Margin calls and staggering losses have cascaded.  The yen was already on its way higher long before the recent tiny rate hike by the BOJ.  

Going forward, I stick with my longer-term forecasts.  Dollar yen’s ultimate downside target is much, much lower than here, but the market is extremely oversold right now.  We need a pause, which means the market will start to bounce and correct for a while.  Then we can commence again.

The other thing that I found amusing this morning was the surprise visit of Claudia Sahm, the creator of the very simple Sahm Indicator during her time at the Fed.  On June 25, I wrote, “It is named for Claudia Sahm, a former Fed employee who devised the rule, and it is particularly popular because it is both very simple and it triggers a very small number of false positive signals. It was first published by the St. Louis Fed as an indicator to help gauge more quickly when the Federal Government should step in with fiscal support to help offset the onset of a recession. The Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate rises by one half of one percent relative to its low during the previous twelve months.”

Her indicator is shockingly simple, and shockingly precise.  What is particularly shocking about it is that no one at the Fed had thought of it before her.  In any event, the Sahm Indicator got officially triggered on Friday, informing the world that the US is in a recession.  I maintain that the recession started months ago since the employment numbers are so misleading about the true weakness of the labor market.   Ms. Sahm was clearly told to downplay the accuracy of her indicator and suggest that it is not ALWAYS correct.  It was patently obvious during her interview that she was trying to suggest that it is possible that the Fed could still somehow forestall the recession and guide us towards their fantasy of a soft landing.   Sure, it is possible, but she avoided addressing the probability of that.  In fact, the momentum of the moving averages make this dream-like soft landing almost unimaginable.  She was paraded out as the stocks were melting down, the yen was surging, interest rates were crashing, and the financial world looked like it would implode. She was clearly told to try to calm down the markets and not talk about the inevitability of the recession – that we are already in!!  

Only one Fed official came out to calm things down this morning by making an amusing pronouncement that the Fed doesn’t place too much stock in one month’s data?  Seriously?  Is that the best they could come up with today?  How about telling us the truth.  You guys absolutely bungled your rate hikes by reacting way too slowly to the obvious build-up of inflationary pressures, and you have moved way too slowly to address the sharply decelerating economy.  I will give you guys a partial pass on the last blunder because the trillions of dollars of debt spending and the many trillions of extra dollars on your balance sheet complicate the situation quite a bit.  The current market sell-off is tame compared to what will happen if the Fed goes wild cutting rates, triggering a resurgence in inflation even as the GDP turns negative.  Let’s hope the guys in Washington don’t bow to the political pressure to prop things up with further policy blunders.

Has the Fed done an economic analysis of what our GDP would look like if our leaders in Washington hadn’t just blown out our federal deficit by roughly $8 trillion in the past 3 ½ years, pushing our total debt past $35 trillion?   How about if the Fed hadn’t expanded its balance sheet by trillions of dollars?  How about a simple answer – our GDP would be sharply negative!

I hope you have heeded my warnings and at least taken some protection against these recent moves, and hopefully, profited from some of them.  As always, wishing you all the very best of luck with your trading.

Andy Krieger