As you can see in the chart below, today’s stock market was hit hard. The Dow tumbled more than 1,000 points. Every Dow stock down and all 11 sectors of the stock market down. Extreme volatility not seen in the stock market since the Covid crash in 2020 was seen in the VIX today. Better known as the “Fear Index”, the VIX at one point intra-day had soared over 100%. Before the 2020 bear market, I last saw that extreme spike in the volatility index during the Great Financial Crisis in 2008.
Today investors experienced the unwinding of perhaps the biggest ‘carry trade’ the world has ever seen. As if the calamity caused by the Japanese yen carry trade was not enough, the market’s Monday news included a report that Warren Buffett had sold half of his Apple stock, Middle East war fears were ramping up, Google lost a massive DOJ antitrust case, and lingering economic concerns have the market suddenly expressing recession worry. While all the above developments are enough to impact the stock market, the carry trade and its sudden unwinding was likely today’s biggest stock shock. The Japanese yen carry trade unwinding caused the Japanese stock market to crash the most since Black Monday 1987. While a carry trade may not be understood by most, unfortunately many are learning that lesson today.
A carry trade involves borrowing and selling one thing, then taking that cash and buying something else—hoping to earn more from the asset purchase than it costs to borrow the other one. The carry trade du jour is the “Yen carry trade”. In this high risk currency trade, speculators borrowed the Japanese yen and bought investments from the U.S. dollar, to AI growth stocks, and gold to cryptocurrencies. This is inherently greatly leveraged with borrowed money which can magnify returns, but when caught of guard can cause dramatic losses. This often does not end well, especially when an unexpected event causes a spike in the price of the side borrowed and sold short (the trade being “carried”). The investor is forced to by back what was first sold with borrowed money and as a result must sell the investments bought – the unwinding of the carry trade. The chart below shows the sudden steep plunge in the Japanese yen relative to the U.S. dollar. The yen fell to its lowest in 34 years. The panic to unwind this yen carry trade sparked a broad-based violent sell-off in securities worldwide.
One of my first thoughts this morning when assessing the global stock market sell-off was recollection of the October 1997 “Asian Contagion” market crash. A currency crisis that started on Thailand devaluing the bhat spread quickly throughout south east Asia and triggered a worldwide market crash. By the end of the day on October 27, the Dow fell 554.26 points, or 7.18%, to 7,161.15. Back then, this was the 12th biggest percentage loss and 3rd biggest point loss on record. The Nasdaq Composite fell 7%, or 115.41, to 1,535.51. The S&P 500 fell 64.63, or 6.86%. By late January of ’98 the U.S stock market was back near new highs. So, these unexpected world events can impact our stock prices anytime. As investors, we are wise to not let such occurrences to abandon our investment plan. Holding a well balanced, diversified portfolio with a strategy to reduce market risk will help an investor avoid panic mode and keep them invested to reap the rewards when markets turn back up – like after the “Asian Contagion” crash.
Here’s some wisdom on investment risk by Warren Buffett’s teacher, Benjamin Graham…
“I don’t think the objective of investment should ever be to take a risk in order to get a return. I think the objective of shrewd investment should be to find opportunities which offer a larger return than the average, combined with adequate safety.”
Benjamin Graham
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Hope this was helpful.
John
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