A Mix of Greed and Fear

The difference in a day… Is that it?… Adjusting expectations and unwinding a big trade… A mix of greed and fear… Complacency kills… Send us your most pressing questions…

Mr. Market exhaled today…

We closed yesterday’s edition by writing that while we were staying attuned to potential more downside in the markets, yesterday’s panic could also “be just that, followed by a bounce and a breather.”

That’s what we saw today. The major U.S. stock indexes snapped back from yesterday’s “everything is down” performance. Bonds rose a little. The CBOE Volatility Index (“VIX”), which some call the market’s “fear gauge,” was around 25… half its peak level yesterday morning.

The tech-heavy Nasdaq Composite Index and benchmark S&P 500 Index were up roughly 1%, the small-cap Russell 2000 Index closed 1.2% higher, and the Dow Jones Industrial Average was up 0.7%. Bitcoin is up 4% to $56,000 in the past 24 hours.

Is that it? Is this market “correction” over? Or is something more still to come?

We can’t know the future with certainty. But as I (Corey McLaughlin) also wrote yesterday, even if we saw a rebound today, “that doesn’t mean the recession risk that caused the anxiety isn’t a legitimate fear.”

One day doesn’t change that thought. The jobs market is still weakening, which means risks to consumer spending, corporate profits, and everything that comes with hits to those economic pillars.

However, with 24 hours of perspective, yesterday (and the few days of selling late last week) looked like a few things…

A recognition of a possible ‘hard landing’…

First, investors were adjusting to expectations of a possible recession ahead and then what the Federal Reserve might or should do about it.

Before a stretch of labor market data at the end of last week that looked increasingly weak, federal-funds futures traders were heavily expecting just a 25-basis-point cut at the central bank’s next meeting in September and perhaps another by the end of the year. Now, they’re counting on a fed-funds rate that’s 100 or 150 basis points lower than its current level by the end of 2024.

The fact that the S&P 500 sold off by about 6% since last Wednesday’s close – and 8.5% since a previous all-time high last month – appears to be a reasonably appropriate response to this change.

It might be even smaller than you’d expect for such a shift from a prevailing expectation of “gradual interest-rate cuts are coming/soft landing” to “we need bigger cuts because of a weakening jobs market/hard landing.”

A big trade…

Second, and something that contributed heavily to the volatility spike Monday morning, was a central bank decision last week in Japan. The Bank of Japan raised interest rates only 0.25 percentage points higher (from near zero)… But that’s a huge deal for a country that had negative rates as recently as March as officials encouraged a weaker currency for several decades to combat deflation.

As we wrote yesterday…

A Bank of Japan announcement last week about interest rates going higher there, combined with the growing idea of lower U.S. rates, strengthened the yen against the dollar and cratered Japanese stocks.

It was Black Monday, revisited in Japan, with the worst day for its benchmark stock index (12.4%) since October 1987. The Nikkei 225 was down 25% from an all-time high hit less than a month ago.

Why such a big move in Japanese stocks?

A mix of greed and fear…

As Stansberry’s Investment Advisory lead editor Whitney Tilson wrote in his daily newsletter today…

The Bank of Japan’s decision last week to raise interest rates for only the second time in two decades (albeit to only 0.25%) surprised investors and triggered a frantic unwinding of a popular, leveraged “carry trade”…

A carry trade is when an investor borrows money from a country with low rates and a weak currency – such as Japan and the Japanese yen – and then invests that money in assets of another country with a higher rate of return – such as Mexico and the peso.

However, if the weak currency suddenly strengthens, as the yen has done in the past month, surging from 162 to the dollar to 145 today – a stunning move in a market usually measured in pennies – it can trigger huge dislocations.

This carry trade was a classic case of “picking up pennies in front of a steamroller” – a phrase describing investments in which there are small, steady profits… but also the risk of catastrophic losses. (For other examples of this – and how they often blow up – see my e-mails from June 4 and January 20, 2023.)

There’s also the simple fact that investors perhaps had gotten complacent with the way things were going… The “carry trade” is just one example… After all, savvy investors would have known about the shift coming in Japan for at least a few months.

Officials there had been suggesting the possibility of higher rates for a while – and first raised them in March. The Japanese economy was calling for it. As we wrote in April…

Inflation is back in Japan. The Bank of Japan (“BoJ”) expects between a 2.5% and 3% annual rate this year, yet its monetary policy is still brutally loose… with a benchmark bank lending rate between 0% and 0.1%.

In February, Japanese stocks made their first new all-time high since 1989. That month, before the Bank of Japan raised rates for the first time this year, we also wrote about BoJ officials weighing higher inflation risks and its negative-interest-rate policy.

At the time, while the Fed was in “higher for longer” mode, Japan’s currency was depreciating against the dollar to the point the bank intervened to support it in April. Remember, traders were “breaking the yen.”

For about a month, the dollar has been weakening relative to the yen (as expectations for interest-rate cuts in the U.S. have grown). So that “yen breaking” story and associated trades from “big leveraged investors,” as Bloomberg’s Matt Levine put it yesterday, have been unwinding. The big shift in U.S. interest-rate expectations accelerated the action.

As Whitney wrote today…

I suspect that the “big leveraged investors” Levine refers to, who got caught with their pants down on the yen carry trade, are also long the tech- and AI-related stocks that have been driving the market… and hence we’re seeing spillover effects.

I’ll also note that the markets have been unusually tranquil, which breeds complacency and excess leverage.

Today, the yen weakened slightly against the dollar, and Japanese stocks recovered. The Nikkei 225 gained nearly 11%, its best day since October 2008. The panic subsided for now.

Complacency kills…

For much of the year, the story in the U.S. was about continued “disinflation”… a labor market gradually weakening but not cratering… a central bank signaling rate cuts to come… and a stock market hitting new all-time highs. Things change. Risks appear.

Hopefully, you at least had an eye out for this. We did. As I wrote in our July 11 edition…

The Stansberry’s Investment Advisory team’s Complacency Indicator, which has an excellent track record of predicting 10% drawdowns in the S&P 500 within the following 12 months, triggered earlier this year.

So there are risks ahead. Two to consider are a deflationary trend and/or a spike in the unemployment rate. Either of these would likely not result in a “mixed” market reaction… but instead a bearish response.

It’s one thing to wake up and see one deflationary reading while the Fed is itching to cut rates. It’s quite another to see sustained deflation and job losses when our financial system is hooked on debt, fiat currency, and consumer spending, which drives roughly 70% of U.S. economic activity.

So don’t forget about the prospect of bad news for the economy potentially becoming “bad news” for stocks.

That was the story yesterday. Today, not so much… but be careful of thinking we’re totally out of the woods about “bad news” for the economy being “bad news” for stocks quite yet.

Stick to your stops. Stay tuned to our editors’ instructions and insights. Today, for instance, DailyWealth Trader editor Chris Igou showed his subscribers three tools for helping folks “survive a market crash,” including the case for owning gold through a recession.

Some more perspective…

Stansberry Research senior analyst Brett Eversole shared some perspective in this morning’s DailyWealth. He said that this recent sell-off is actually “normal.” As Brett wrote…

U.S. stocks are darn close to hitting the 10% decline that qualifies as a market correction. But let’s put the recent pain into context…

In the chart below, you’ll see that stocks are nearing a 10% decline. But even with that fall, the S&P 500 Index is only at a three-month low. Take a look…

It has been a stellar year for stocks. So even after this decline, we’re sitting at the same levels we saw in early May.

Of course, things could still get worse. But we’re not seeing years of gains evaporate. This decline isn’t nearly as bad as it seems at a glance.

This kind of drop is also perfectly normal. In fact, it needs to get a bit worse to even count as “normal”…

Brett then looked at the worst “intra-year” declines for U.S. stocks since 1950 to see if any patterns about the past could educate us about what could happen in the future. As he found…

Right now, U.S. stocks are down about 9% from their July high. Since 1950, the average intra-year decline was 14%. The median, which gives less weight to the extreme readings, was a fall of 11%.

So it might feel bad right now. But history tells us the decline we’re seeing is even a little shy of the expected range for a given year.

You can see the data in more detail in the chart below. It shows where each year’s maximum fall landed within each range – which gives us a sense of how often these declines occur. Take a look…

You’ll notice that we’ve almost never seen years with a decline of less than 5%. That has only happened seven times in 74 years. It’s nearly as common to see a decline of 30% or more.

Instead, almost all years fall into the range of a 5%-to-20% max decline. And the most common range is a fall of 10% to 20%. That means seeing an intra-year correction is more common than not.

So again, these kinds of declines are normal in risk assets like stocks.

We even saw one of these similar pullbacks just last year, back when recession concerns first started appearing as the unemployment rate began to tick higher. Brett’s point was to beware of “knee-jerk reactions” and letting “fear” drive your investing decisions.

Coming soon…

Of course, we’ll keep you updated here in the Digest as well.

In tomorrow evening’s edition, we plan to send all readers a special “Town Hall” video update to cover all the pressing topics and concerns folks might have right now.

The panel discussion will include our Director of Research Matt Weinschenk and a collection of our top experts…

If you have a question or topic you want Matt and our team to answer or cover, send it to us tonight at feedback@stansberryresearch.com. We plan to record the video tomorrow morning, so don’t hesitate to be an early bird and get your questions in.

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Recommended Links:

JUST RELEASED THIS MORNING: ‘This Is How I’d Invest $1 Million Today’ This morning, legendary investor Whitney Tilson just posted a new portfolio of stock picks. He isn’t buying the Magnificent Seven… or putting an equal amount of cash into each. Instead, he’s using the Monte Carlo method to see which of 4,817 stocks could double your money. Click here to learn more before it goes offline in 72 hours. BEWARE: ‘The Most Dangerous Investment in America Today’ MarketWise CEO Porter Stansberry accurately predicted the world’s largest mortgage brokers – Fannie Mae and Freddie Mac – were headed toward bankruptcy. He did the same with General Motors in January 2007. Now, he’s issuing a new warning about what you should sell immediately (this will surprise you). Find out more here.

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New 52-week highs (as of 8/5/24): Kellanova (K) and Vanguard Short-Term Inflation-Protected Securities (VTIP).

In today’s mailbag, a question about something we recently published… Do you have a question or comment? As always, send your notes to feedback@stansberryresearch.com. That includes any questions you might have for our team before we record the special “Town Hall”-style update that I mentioned earlier.

“Greetings, Recently in a communication from Stansberry (I think it was in the Digest), there was a lesson that I want to pass along to my niece who is in middle school and taking an interest in personal finance.

“It was a reference along the lines of ‘If a person invests X amount of dollars at age 20, and only invests that same amount annually for 7 years and allows the earnings to compound they will end up with XXXXX dollars at the end of several decades.’ That was compared to if a person waited later in life to begin investing and then continued investing for decades. The person who started earlier ended up with more money, even though they had stopped investing new money after only 7 years.

“I’ve been searching for that nugget of information but cannot put my hands on it. Could someone please send to me? Thanks!” – Subscriber Scott H.

Corey McLaughlin comment: Scott, what you are looking for is last Thursday’s Digest, which was a slightly edited archived essay from our founder Porter Stansberry. In it, Porter shared wisdom from the late, great financial newsletter writer Richard Russell. As Porter wrote…

For nearly six decades starting in the 1950s, he wrote Dow Theory Letters. If you’ve never read his famous essay “Rich Man, Poor Man” before, stop whatever you’re doing and click on this link to read it.

To explain the power of compound interest, Russell notes that if a 19-year-old put $2,000 each year into his IRA for seven years in a row and then never contributed another penny to his retirement, he’d have $1 million by the age of 65, assuming he earned 10% a year on his account on average. If another investor started saving for retirement at 26 – the same age the first investor stopped contributing – and he put $2,000 into his IRA every single year until he was 65, he still wouldn’t catch up to the first guy.

Now, lots of folks who see this information think, “Oh, it’s too late for me. I don’t have enough time to compound my wealth.” No, that’s not true. What this presentation really means is that you have to start now. You have to learn to be a saver. You have to make sure your money is earning interest all the time. Most of all, you must realize if you’re borrowing money (without a positive “carry,” meaning earning a higher percentage return than what it costs to borrow that money), you will never, ever be rich.

I hope this helps. I would also urge your niece (and anyone) to read the entire version of Russell’s “Rich Man, Poor Man.” I wish I had known about it when I was in middle school. Thankfully, I at least had a social studies teacher who went rogue from the curriculum and introduced us to stocks… but I discovered Russell later than I’d like.

Coincidentally, in the excerpt above, you may have also just noticed the mention of the concept of “carry” again, like we discussed regarding the yen and the dollar in today’s edition. You can see why savvy investors care so much about it.

All the best,

Corey McLaughlin
Baltimore, Maryland
August 6, 2024