The Carry Trade Continues To Unwind

Summary
• The tech sector’s recent 5% decline is driven by the unwinding of the carry trade, yen
strengthening, and economic slowdown fears.
• The Bank of Japan’s unexpected rate hike and U.S. economic data have influenced the
yen’s rise, impacting tech stocks.
• Despite current market sentiment, strong earnings expectations for the S&P 500 suggest
potential future growth.
• Monitoring the yen and U.S. dollar charts is crucial, alongside weekly jobless claims and
upcoming election impacts on market stability.

Tatomm
The tech sector took another 5% or so hit again this past week. The fundamentals (earnings prospects) for the market (especially tech) remain strong, however, despite the ugly sentiment against big tech in recent weeks. We will take a closer look at these earnings expectations towards the end of this article.

But for now, let’s deal with the current sell-off in tech. There are three main reasons that have turned the sentiment sour against the market for now.

First and foremost is the unwinding of the carry trade. Going long on tech and short on the Japanese yen have been two very popular trades in recent years. This has become a very crowded trade. The yen has been the cheapest source of borrowing for many years and traders have been using these funds to go long tech.

Not all the borrowed money has gone into tech, but it would be a reasonable assumption that a good part of it has. As you can see from the chart above, there is a direct correlation between the strengthening of the Yen against the dollar and the sell-off in tech.

Correlation between yen and tech. (Schwab.com)
According to Schwab, “the yen rose 14% against the dollar in less than a month (July 10 to August 5) causing assets to decline in value against yen-denominated borrowing used to fund those purchases, forcing some investors to unwind their trades. The dramatic moves in markets globally on August 5 indicates this likelihood of forced selling, similar to a broad-based margin call.”

“A combination of things likely fueled the recent move in the yen. On July 31, the Bank of Japan (BOJ) surprised with a bigger than expected rate hike and committed to further rate hikes along with faster than expected quantitative tightening (reducing the assets on their balance sheet purchased during a more than decade-long period of quantitative easing). Additionally, worsening U.S. economic data and some disappointing updates from some mega-cap tech companies weighed on the dollar and stocks generally.”

I will be watching the chart of the Japanese Yen in coming days. As you can see from the chart below, the Nasdaq started falling at exactly the same time that Yen started rising. It would stand to reason that as soon as the current #2 uptrend in the Yen begins to level off, the tech stocks can begin their upwards move once again.

Once again, I base this on earnings expectations that we will take a look at in a bit.

As you can see from the chart above. The Yen is coming up on some strong resistance, but as you can see from the chart, it could go higher. I would put this chart of the yen on your daily watch list as the market is currently taking its cue from it.

Much of the yen’s future depends on the Bank of Japan that has stated its intent to raise rates more while the U.S. is getting ready to lower rates. This would drive the Yen higher if Japan follows through. Going long the Yen (NYSEARCA:FXY) and short the Nasdaq with PSQ, QID, or SQQQ would be the way to hedge this current move.

I will also be watching the chart of the U.S. dollar. It needs to start strengthening once again. If it instead breaks down, more hedging and selling of stocks will be required.

I have sold AMD, ASML, ELF and a few others so far. They have fallen a lot more since I sold them. I have also added a hedge to all of my portfolios with just SH (inverse the S&P 500 1X) for now.

Reason #2 for the current sour sentiment on the market is fear of a slowing economy. The economy is definitely slowing down, but there are still not any signs of a recession on the horizon. I continue to watch the weekly jobless claims for clues to a slowdown in the jobs markets. This will more than likely be the first signs of an approaching recession.

For now, weekly jobless claims remain low, but if they begin to rise, that will spell trouble ahead in the economy.

Reason #3 for the recent weakness in tech is the approaching election. The big debate is on Tuesday and election day is now less than two months away. Americans could not have a starker choice between ideologies. Taxation, regulations, foreign policy will be the three biggest issues that the stock market will have to grapple with.

What will America decide? No wonder that despite solid fundamentals, the market is a bit nervous right now.

Now, during my 25 years as a professional money manager, I have found the most reliable indicator for the market, bar none, to be earnings and earnings estimates.

The Gunderson Rule States as follows: Stocks and Indexes Follow Earnings.

Why has the market been going up since 2009? The answer is simple: earning, earnings, earnings.

As you can see from the chart above, earnings for the S&P 500 have been going up since 2009 when the S&P finally bottomed out at the Biblical number of 666 after the financial crisis and great recession of 2008-2009. The only year earnings have not grown since then was the COVID-19 year of 2020.

In accounting terms, we call that occurrence an “extraordinary item” that hopefully will not occur again. Earnings have gone on to make all-time record highs and are expected to do so once again this year, next year, and the year after that.

Yes, a lot can happen between now and then, but for now, the market is going to trade on those expectations until they change.

2023=$217.66 (est.)
2024=$241.06 (est.)
2025=$278.04 (est.)
2026=$312.11 (est.)

Go ahead and slap a 20X multiple on those earnings and calculate your own target price for the S&P 500 and the market will start to make sense to you. You can make the market as complicated as you want, or you can keep it simple. It is up to you.