The Week in Review: August 12, 2024
A Rollercoaster and the Carry Trade
Ask the average investor what inflation or unemployment is, and they can give you a good working definition. Ask them about the ‘carry trade,’ and you’ll likely get a blank stare. Even the term itself isn’t intuitive.
However, a sudden unwinding of the carry trade forced a market wipeout in Japan on Monday, and weakness spread across the globe.
According to Reuters, the best-known measure of Japanese stocks shed 12% on Monday, the worst trading day since October 1987.
The damage was more contained at home, with the Dow shedding just over 1,000 points, or 2.6%, according to the Wall Street Journal. As the week progressed, cooler heads prevailed, but let’s return to our original thought—the carry trade and its influence on trading last week.
What is the carry trade?
Simply put, borrow in a low-rate or no-rate currency, like the Japanese yen, take the proceeds, and invest in what are expected to be higher-earning assets, such as Japanese stocks, U.S.-based tech stocks, or even higher-earning Treasury bonds.
Sophisticated investors who place such bets are aware that the carry trade can suddenly blow up (via rising borrowing costs, a rising yen, or a selloff in the assets being purchased). They also gambled that the low-volatility environment in Japan would persist. It didn’t.
You see, while the rest of the world was raising interest rates in 2022 and 2023, Japan kept its key rate near zero. That made the carry trade profitable.
However, that began to change at the end of July when the Bank of Japan increased its key rate to 0.25% and announced that it would gradually reduce bond purchases (Bloomberg).
Consequently, the yen soared, and margin calls forced the pension funds, institutions, and hedge funds that had taken advantage of the carry trade to liquidate positions. Call it an unwinding of the carry trade.
Markets calmed down when the governor of the Bank of Japan began to rethink talk about rate hikes when markets were unstable. According to Bloomberg, JPMorgan estimated that about three-quarters of the carry trade had unwound on Thursday.
Meanwhile, the labor market is softening, and the odds of a recession have risen, but talk of an imminent downturn seems premature, which also helped markets stabilize.
As of August 8, the Atlanta Federal Reserve said its Q3 GDPNow model is tracking at a 2.9% annualized pace. Yes, it’s very early in the quarter, but 2.9% is far from recessionary.
Stats and the playbook
Since peaking on July 16, the S&P 500 has shed 8.5% through Monday, August 5, its most recent low (S&P data from Yahoo Finance).
According to LPL Research, the S&P 500 averages a 10% correction, or more, every 12 months. The last such 10% pullback occurred almost a year ago.
What has happened since mid-July is far from unusual. What would be unusual? A calendar year in which the S&P 500’s maximum peak-to-trough decline failed to exceed 8%.
Intuitively, investors recognized that. But when a pullback unexpectedly occurs, it can create jitters.
We have entered the historically uncertain months of August and September. On top of that, the upcoming election and tensions in the Middle East loom.
We know that volatility can sometimes be unnerving. Yet, we also know that market pullbacks are to be expected from time to time. Pinpointing them in advance, however, is quite difficult. Those who may correctly call one market downturn often struggle to predict the next one.
Successful investors understand that emotion-based decisions are seldom profitable over a long period.
Historically, the key to building long-term wealth has been to maintain a well-diversified portfolio that taps into the long-term upward trend in major stock market indexes while also reducing risks during uncertain times.
It is an investment plan that is carefully tailored to one’s long-term goals, investment timeline, and tolerance for risk.
Market Summary
Two for the Road
When the Carter Center began leading the international campaign to eradicate Guinea worm disease in 1986, there were an estimated 3.5 million cases in at least 21 countries in Africa and Asia. During the first three months of 2024, not a single case was detected worldwide. If this continues, we could soon achieve the global eradication of the third disease in history. - Carter Center, April 28, 2024
If you started with $10,000 in 1961 and invested in the S&P 500 only when a Republican was in the White House, your investment would have grown to $102,000 in 2023. If you did the same but with a Democrat in the White House, that investment would have grown to $500,000. But none of that compares with the $5.1 million you would’ve had if you stayed invested the whole time. - Yahoo!Fiance,
Please do not hesitate to contact me with any questions or concerns. I hope you have a wonderful week!
Bill Stordahl, CFP®
Managing Director
Stordahl Capital Management
This information should not be construed as investment, tax, or legal advice. This commentary reflects the personal opinions, viewpoints, and analyses of the Stordahl Capital Management, Inc. employees providing such comments and should not be regarded as a description of advisory services provided by Stordahl Capital Management, Inc. or performance returns of any Stordahl Capital Management Inc. Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing in this piece constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Accessing websites through links directs you away from our website. Stordahl Capital Management is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve of or endorse the information provided. Users who gain access to third-party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from the use of those websites. Please note that trading instructions through email, fax, or voicemail will not be taken. Your identity and timely retrieval of instructions cannot be guaranteed. Stordahl Capital Management, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results
1. The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results.
2. The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results.
3. The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results.
4. The Global Dow is an unmanaged index composed of stocks of 150 top companies. It cannot be invested into directly. Past performance does not guarantee future results.
5. CME Group front-month contract; Prices can and do vary; past performance does not guarantee future results.
6. CME Group continuous contract; Prices can and do vary; past performance does not guarantee future results.