Markets are selling off hard around the world. The press will have you believe the move is due to Friday’s jobs report and fear of recession. In my humble opinion, this is absolutely NOT the case.

With the caveat that I am merely expressing my opinion on the matter, I believe the move is being largely driven by Japan. More specifically, the Yen-Carry trade unwinding. This trade has been in place for a very long time as big traders borrowed yen and invested in other, higher-yielding assets. Recently, word is that money had been going into US Megacaps. But, when the BOJ raised rates, as it did last week, the trade breaks down – as your cost of capital goes up dramatically given the leverage generally used.

So, traders are forced to sell their highly leveraged positions. This explains why Japan fell -12.4% overnight, the biggest decline since the Crash of 1987.

This type of trade then reverberates around the world. Suddenly, highly levered hedge funds MUST de-lever – and fast. So, what do they sell? As the cliché goes, “Sell what you can, not what you have to.”

It’s not a stretch to imagine that margin calls may be occurring here. Why else would traders just dump everything all at once? In short, it’s because they are forced to.

Is this the start of a global panic or a move that sends the U.S. into recession? Personally, I don’t think so – not one bit.

We’ve seen this movie before. Perhaps the best example was in 2020 when everyone panicked over COVID. All kinds of forced selling occurred. ETFs started to “break.” It was indeed ugly there for a while. But then clearer heads prevailed and a robust rally occurred as the sky didn’t fall after all.

This is not to say the bear arguments aren’t gaining traction. The yen-carry unwind, the selling from “systematic longs” (think risk parity trades that strategies that need to be rebalanced every month), worry over AI monetization, increasing Middle East tensions (Iran likely to attack Israel directly after Hamas leader killing), political uncertainty in US, and don’t forget an oldie but a goodie, negative seasonality (reports indicate the 1st 2 weeks of August are the 5th worst of year historically).

Now mix in the fact that corporations aren’t allowed to buy back their stock (usually a source of support) until after they report earnings, and you’ve got a bunch of traders selling with potential buyers sitting on their hands. A very nice recipe for panic selling.

To be sure, we’ve seen this movie before. This type of thing has happened many times. While there is no guarantee how long it lasts this time, we’re usually talking about days/weeks, as opposed to months. Once the forced selling is complete, it tends to be over.

But… With the current intensity of the selling seen here, it is a safe bet that there will likely be some “fund blowups” as highly levered funds can’t meet margin calls. This, of course, produces more forced selling. Rinse and repeat. And as word of blowups leaks, traders get wind of the moves and exacerbate the situation with short selling.

It is also worth noting that the macro backdrop hasn’t really changed much in the last 5 days. While the bears are screaming about recession (again – how’s that been working out?) due to the Jobs report, the bottom line is Friday’s Employment Report was “riddled with weather-related impacts” which overstated the perceived weakness in the report.

My take is that while the economy is indeed slowing, it is slowing from a high rate of growth. Last I checked, GDPNow showed the current growth rate to be 2.5%. Not bad for a purported debacle.

I’d also like to point out that this morning’s ISM Services report came in showing that the services sector remains in expansion mode, with New Orders, the Business Index, and Employment jumping 5 points each (and in solid territory). And with Services representing more than ~70% of the economy, I don’t think we need to “sound the alarm” just yet.

Finally, lest we forget, if the global selloff gains traction or the economy starts to falter, the Fed, in the words of Chicago Fed President Austan Goolsbee, “will fix it.” So, before you run and bury your head in the sand, remember that the Fed Put could be back in play soon if the ugliness continues.

My $0.02 on the matter is that what started out as a corrective phase has accelerated wildly (the VIX shot up over 65 this morning) and looks to getting a little ridiculous. For me, the bottom line is this creates opportunities. While we don’t know where/when the bottom is, prices of the best companies with the best earnings/sales growth are now on sale, in a big way. As such, I’d be a selective accumulator my favorites into the panic.

Thought for the Day:

Be fearful when others are greedy and greedy when others are fearful. -Warren Buffett

Market Models Explained

Wishing you green screens and all the best for a great day,

David D. Moenning
Director Institutional Consulting
Capital Advisors 360, LLC

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned:

None

– Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES

Tags: David Moenning, State of the Markets, Stock Market, Stocks, Stock Market Commentary, Stock Market Analysis, Investing, Federal Reserve, Inflation, Rate Hikes, Fed, Jerome Powell