It's carnage out there in the markets, and things have been moving with the force of a tsunami.
Japan's Nikkei 225 plunged more than 12% on Monday in what was the biggest single-day drop since 'Black Monday' in 1987. As of this writing, the Dow has dropped some 1,000 points, while the Nasdaq has cratered nearly 4% in what has turned out to be a global market rout.
The triggers for the selloff are clear enough and have been well covered in the financial media. Friday's disappointing US jobs report ignited fears of a US recession. The once-hot but overly leveraged and overhyped AI trade has gone sour, which has led to a bloodbath for tech stocks.
Largely responsible for the latter development is the breaking of the massive dollar-yen carry trade - where investors were borrowing cheaply in yen and investing in higher-yielding US assets. This can be thought of roughly as a big interest-rate arbitrage: Borrow at low rates and lend (invest) at higher rates. But when the Bank of Japan raised rates on July 31 and, perhaps even more importantly, signaled more hikes to come, a massive capitulation in these carry-trade positions ensued. This has reverberated through markets and led to a lot of margin calls. And since investors often have to sell other assets to meet margin calls, it creates even more selling pressure.
Predicting where markets may be headed in the coming days and weeks is a hazardous endeavor that I won't venture. Many investors are of course trying to catch the proverbial 'falling knife' - meaning buying in during or immediately after a sharp selloff. A number of analysts are already saying that the panic is overblown and things will soon stabilize. If I had high conviction about how things will shape up over the short term, I would simply trade the market, not write about it.
So instead of shooting in the dark with a forecast, let's figure out how to think about what's going on. And it's always good to step back a bit and try to find the bird's eye view in the midst of turmoil. First, there's the obvious: This is really a fairly classic instance of a positioning unwind rather than a response to an economic shock. A lot of equity investors got in too deep chasing the bubble in tech stocks - and a lot of these unfortunate folks were borrowing cheaply in Japanese yen to do so (see above about the carry trade). There are a lot of margin calls going on, a lot of forced liquidations on leveraged positions - and probably a lot of wives securing the windows in the high rises....<<<Read More>>>...
