Stock Talk - Yen There Done That – August 2007

Starting point is 00:00:00 Investors' global stock markets sold off violently two weeks ago, and the cash S&P 500 opened Monday, August 5th, down another minus 3%, to take the index down minus 9.7% from peak to trough over the past three weeks. That, of course, if you were a perfect seller and buyer. The current thumping started on Friday, August 2nd, when markets in America dropped in response to a smaller number of jobs created in July. The Japanese markets took a tumble on Monday posting their biggest ever one-day drop in the Niki, that's the Japanese equivalent of our S&P 500.

Starting point is 00:00:35 Since then, markets have moved up and down as investors attempt to understand what is going on. Later last week, the markets rallied strongly and ended the week, basically spot-on flat for the week and minus five and three-quarters percent off its July 15th, closing high. The cause? According to most financial networks, which were almost uniformly in hysteria mode, that the global market were crashing in an unprecedented way, the blowing up and unwinding of the yen carry trade. In fact, some so-called financial pundits have attributed the yen carry trade as the primary driver of global markets the last few years. Investors, in my view, this is utter nonsense. Quickly reviewing what a carry trade is, simplistically speaking, a carry trade is when an

Starting point is 00:01:23 investor borrows in a currency with a low interest rate, such as the Japanese yen for the last decade, and then that investor reinvests the proceeds in a currency with a higher rate of return. Most recently, the example has been Australia. Japanese investors and hedge funds have been pyramiding this strategy in recent years, borrowing cheaply in Japanese yen, while interest rates are still low, about zero, and investing in places where rates are higher, such as the United States, where interest rates are five and a quarter to five and a half, where even places like Mexico, where interest rates are 10 to 11%. Researchers at UBS estimate that more than 500 billion in U.S. dollar yen carry trades have

Starting point is 00:02:06 taken place. When the trade begins to reverse course, for whatever reason it might be, be it interest rate differentials, monetary policy changes, or just the change in the pattern of that squiggly line on the chart, many quantitatively driven funds are forced to reverse course and de-leverage their investment positions. Folks, when too many investors are playing the same game trade, this can result in a cascade of selling, as we saw in Japanese markets, with the Niki being down minus 12% in one day. This move brought out the Dumers and hysteria permaveres calling once again for 1987-like crashes. Investors, it's not 1987, not in the economy, not in the markets, not in interest rates, not in the stock chart patterns. In fact, if it did say, it did say, it's not in

Starting point is 00:02:53 set up that way, anyone who missed out on the last three to five year stock run-up and was sitting in cash, or even those who were all in long but not on margin or leverage, should be hoping it is 1987. Why? Because in 1987, the S&P 500 was up almost 35% in October, before following back to negative year-to-date territory in a few weeks and finished the year marginally up. And even after October 1987, the S&P 500 went on to gain over 125%. over the next six years, compounding at almost 20% per year. Investors, I would love this to be mid-1987. It's not. Investors, those citing the recent implosions on the Yen-carry trade in late July and the first week of August either have a very short memory or need to learn how to do a basic Google search.

Starting point is 00:03:42 It's not 1987. But unfortunately, it could be 2000, or even worse, 2007. We've discussed similarities numerous times over the last 18 months, to the 1998 to 2000.com internet buildout, both good and bad. We've also discussed how the Fed is acting in a similar way to 2007, how some of the data series, such as real-time, real interest rates set up in a similar pattern to the summer of 2007.

Starting point is 00:04:10 During both periods, the Fed was too tight for too long, and economic slowdowns morphed into recessions. Granted, both these periods were pre-E policy time, periods. Investors, the last yen carry trade blow up that few investors remember? Yep, almost to the day back in August of 2007. In fact, here's an excerpt from the New York Times on August 17th, 2017. And I quote, the recent volatility in global stock markets has raised the prospect that a distinguishing feature of the financial world for years now, an investing tool known as the yen carry trade might be coming to an end. The unwinding of the carry trade sent the yen soaring Friday

Starting point is 00:04:50 to its highest level against the dollar in 14 months, as the Niki 225 index suffered its worst single-day loss since September 11, 2001, the attacks on the United States. Here's the link to that full article. Investors, besides the Yen-carry trade implosion in August of 2007, what things are reminiscent of that pre-QE time period as well as the summer of 2000? As we previously discussed, both the absolute level and now chart configuration of real-time, real interest rates. Only in the summer of 2000, in the summer of 2007 did one-year real interest rates exceed 4%, as they have done recently. During both prior periods, the Fed acted too slowly and recessions transpired over the next nine to 15 months. Here's a chart of the very long-term five-year real interest rates.

Starting point is 00:05:40 It is clearly formed a head-and-shoulder pattern as it did in mid-2007. Looking back at the S&P 500 during these periods, the return performance in July, August. time periods earlier are similar to the current pattern seen since the July 15th top. In mid-July of 2007, a short-term summer peak at all-time highs, the market fell about minus 6.5% into early August, and then another minus 3% on a Monday on the back of the Yen-Carry trade blow-up scare. Peek to trough in July, August of 2007, the S&P 500 fell about 9.5%. Before we continue, I want to give a shout out to the entire Oak Carbust team. as the USA Today ranked us as one of the best financial advisor firms in 2024.

Starting point is 00:06:27 The award is given to the top registered investment advisor firms in the United States based on two criteria. The first criteria, recommendations from individuals among 25,000 financial advisors, clients, and other industry experts. The second criteria, growth in assets under management over a year and five years, respectively. I personally am looking forward to helping us move up this list over the coming years by taking care of our current and future client base. So investors, here's what's just transpired in the S&P 500 from the July top, a short-term top and all-time high on July 15th at around 5669, a quick two-week drop of about 6.5% into the weekend, then another minus 3% drop on Monday

Starting point is 00:07:10 on the back of the Yen-carry trade blowup, bringing the S&P 500 peak to trough, minus 9.7%. If you were perfect, yes, that's almost identical. to August 2007. So investors, if you are now convinced it's the same playbook or a rerun of an earlier period, is it time to panic? History would say, no. There is a better selling opportunity coming

Starting point is 00:07:32 from a higher level later in August, maybe all the way out into September. Why? Because in both years, the lows the first week or two of August were the short-term low for the next three weeks plus in the case of 2000. With last week's rally, we now sit almost exactly on a percentage basis where we did in both August,

Starting point is 00:07:50 of 2000 and 2007, down around 6% off all-time highs. In both prior cases, the markets rallied strongly. In 2000, almost plus 8.5% to near previous all-time highs into month-end, August. And in 2007, over 10% to marginal new all-time highs into September. Investors, such outcomes, if repeated, and that's a big if, no guarantees, would take the markets back to 5,600 to 5, 5755 over the next 2 to 10 weeks. inconceivable to some. Will it happen? I don't know. Can it happen? Sure, why not? The Federal Reserve is likely to start talking devilishly into Jackson Hole and throughout much of September into the Fed meeting. Stock buybacks are now beginning to re-engage and with strong employment numbers, 401k contributions, and buying kick-in on paydays every two weeks. The Fed will look to calm volatility and any exhaling will likely lead to performance anxiety and stock chasing back to the upside. Now the that many leveraged players were forced to sell. Folks, the Fed is too tight. The bond market knew it weeks ago,

Starting point is 00:08:55 and the stock market just came to that conclusion over the last few weeks. Yes, we've seen this playbook before. Before you panic, remember that these were both time periods before the Fed Town QE. That's quantitative easing and many other programs used to dull or delay economic and market downturns. During both these periods, the markets did not cascade lower

Starting point is 00:09:16 from there in a straight line. Since the July CPI report, markets have been volatile and moved down quickly. Historically, we have only seen one significant meltdown around the commencement of a cutting cycle, and that was in 2001. While the previously discussed 2000 and 2007 time periods, the cutting cycles did end in a recession, they were pre-QE and characterized by a lack of liquidity. Quantitative easing in significant size has been implemented since then, and you know what that has historically done to tame volatility in markets.

Starting point is 00:09:47 So as we've messaged for the better part of the last six weeks, if over the years you found yourself reacting emotionally in your portfolio to presidential elections and their uncertainty, or when volatility is high like it has been now, now is the time to step back, take a deep breath, and give your advisor a call to walk through your long-term financial plan. If in the past you felt emotional and compelled to sell stocks when volatility was high and they were down, it might be time to reverse that habit if it hasn't worked out in the past. Maybe it's time to allocate a little more in equities on a pullback. I don't know because I don't personally know you in your financial plan. However, if you have a good relationship with your advisor and not just an investment account relationship, get on the phone and give them a call and see what might work for your longer term financial plan. If you're uncomfortable with a wider range of possible equity outcomes, the Oak Harvest Investment

Starting point is 00:10:40 Team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges and shock absorbers for a stock portfolio. Information on this new strategy of ours can be found at oak harvestfunds.com. From myself and from the whole team here at Oak Harvest, have a blessed weekend. All content contained with an Oak Harvest podcast expresses the views of the speaker and is for informational purposes only. It is Based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice.

Starting point is 00:11:19 Strategies and ideas discussed may not be right for you, and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available. for direct investment and your investment results may differ when compared to an index. Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss and past performance is not indicative of future results.

Stock Talk - Yen There Done That – August 2007

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