August 9, 2024
By Steve Blumenthal
“It’s the things you learn after you know it all that count.”
– Coach John Wooden’s personal note to Bill Walton
Last Monday, the yen surged, and Tokyo’s stock market plunged as the Bank of Japan (BOJ) unexpectedly hiked its policy rate to a 15-year high, departing from near-zero levels. Governor Kazuo Ueda signaled that more gradual rate increases were on the horizon, following a trajectory the central bank had been hinting at for months. Markets didn’t like the move.
On Wednesday, Ueda’s key deputy calmed the markets by stating that the BOJ would hold off on raising rates during periods of market instability. Thank you, Mr. Key Deputy!
Reality resurfaced on Thursday when the minutes from the BOJ’s July 30-31 meeting revealed that policymakers were considering a series of rate hikes to prevent inflation from spiraling out of control – as my old man loved to say, “Stuck between a rock and a hard place.
I spoke with a good friend this week about the tumult in the markets caused by the yen carry trade (see last Friday’s OMR “Bug and Windshield” letter). I had no idea “Black Monday” would follow (as it is being called now); what I knew was the size of the leverage and the inflation challenges Japan is dealing with due to the fall in its currency – a consequence of years of money printing and zero-bound interest rates.
My friend is an avid skier, and every skier knows the exhilarating sensation that comes with skiing deep powder snow. It’s a rhythmic, floating, and seemingly effortless experience. I likened this to the risks of avalanches—how the pursuit of that high can lead skiers into serious danger. The instability lurking beneath the surface is invisible, and the deep, untouched snow can be deceptively inviting. But sometimes, the avalanche risk is just too great to ignore.
Similarly, in the world of investing, the allure of high returns can mask underlying risks. We can gauge these dangers through valuations, concentration, leverage, and euphoria. It’s perhaps no coincidence that Warren Buffett is sitting on so much cash.
I told my friend that each new round of money printing increases risk, just like each new large snowfall increases risk. A new layer of snow that sits on top of the last. The size and frequency of each new storm and the variance in temperatures between storms help determine the degree of instability. Japan has been pouring money into the system for a long time, largely in an attempt to get its economy out of stagnation.
One of Japan’s problems is the massive size of the $20 trillion yen carry trade. In comparison, the U.S. public equity market is approximately $50 trillion in size. $20 trillion is serious leverage. Another problem is that 97% of Japan’s energy needs come from oil, and Japan imports 100% of its oil. Oil is traded in dollars. When the yen goes down, the actual cost of the oil they need goes up. The yen lost approximately 36% of its value vs. the dollar over the last three years. In early July, the BOJ began signaling its intention to raise its interest rates. Its objective is to strengthen the yen. It worked. The yen went from 0.62 yen to the dollar to 0.68 yen to the dollar. But that is still down about 30% from three years ago when the ratio was 0.98 yen to the dollar.
Think about how you would feel if your monthly utility bill went from $600 to approximately $800, costing you approximately $2,400 more per year. This impacts every Japanese business and citizen. A devalued currency is inflationary.
Here are a few key points:
- The BOJ knows it needs to raise the value of its currency, and the way to do so is to increase its interest rates.
- The side effect is the impact on the carry trade. We saw a mini avalanche on Monday.
- There are checks and balances in everything.
- Rising rates in Japan and declining rates in the U.S. make the carry trade less attractive.
- If the 10-year Treasury drops to 3% and the Japanese borrow rates rise to 1%, that 2% spread difference becomes less attractive, and hedging costs, due to increased volatility, will likely move higher.
- A lot of snow has fallen over the past several years. We can’t see what lies below the surface, but we know the leverage makes the system less stable.
- The leverage unwinding could cause a global avalanche.
On Wednesday, the BOJ blinked and stood down. Their currency has rallied nearly 10% since they started signaling rate increases in early July. After the soft BOJ pivot on Wednesday, the yen dropped from 0.71 to 0.68.
The BOJ will try again. This problem is far from over.
The next few months will be especially interesting. The Fed meets in Jackson Hole later this month. Markets are pricing at a 100% chance of a rate cut in September. A few, like former NY Federal Reserve President Bill Dudley, are calling for an immediate emergency rate cut. That would complicate things for Japan and further put pressure on the carry trade.
Leverage is awesome on the way up and bad on the way down. Call the ski patrol before you head out for that deep powder run. The systemic risk remains high.
I have no idea, nor do I believe anyone does, what the next few months will be like. There is a probability north of zero but perhaps less than 20% that a 1987-like market crash could happen.
Regardless, as you’ll see below, the market remains overvalued. Watch the BOJ, the yen vs. the dollar, watch the Fed, and watch the 10-year Treasury yield.
How much pressure will this put on the Fed to not cut rates in September (or sooner)? We’ll soon find out.
Grab that coffee and read on. I share several charts below and a few of my personal targets. Opportunity presents quickly as bear markets tend to V bottom due to the forced selling of leveraged positions. Market makers and would-be buyers back away, and those with margin calls are forced to sell. Put your stock shopping list together and be ready to take advantage should a dislocation opportunity present. And I think you are really going to enjoy this week’s personal section.
On My Radar:
- The S&P 500 and 10-year Treasury Yield Targets (and the Yen)
- Random Tweets
- Personal Note: Coach John Wooden
- Trade Signals: August 8, 2024 Update
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
The S&P 500 and The 10-year Treasury Yield Target Zones (and the Yen)
I am sharing some of my thinking with you about potential target zones. For example, I’m a big fan of high and growing dividend stocks. I just haven’t been bullish on the valuation entry points, but some are looking better. This next chart is one of my favorite valuation charts. What I’m looking for is a move towards 3,700. Frankly, a move below 4,000 would be nice. The latest data based on actual 12-month trailing earnings puts Median PE at 26.3. Needed to reach “Median Fair Value” is a decline of 32.7%. Note the “We’d be better here” green arrows. 17.7 is the 60.4-year Median PE number or “Fair Value”. I’ll keep sharing this chart each month.
Target Zone for the S&P 500 Index is 3,716.51
Source: NDR
10-year Treasury Yield vs. 6-Month Treasury Yield
The next chart looks at the yield difference between the 10-year Treasury and the 6-month Treasury bill.
First, look at the “We are here” arrow. Then, look at all the small arrows placed just in front of the grey areas (past periods of recession). The solid black line is at zero. Anything above the black line means the 10-year yield is higher than the 6-month yield. That is the case the majority of the time. Today, the 2-year Treasury yield is 4.04% and the 10-year yield is 3.99%. A slim -.05 bps.
The yield curve has been inverted for 25 months. That is a very long time, and that is about to change. It is called an “inverted yield curve” when below the 0 line. Think of it as abnormal, something is wrong… the economy has a fever.
Notice how, in every instance, recessions followed when the yield curve became uninverted. Avoidable? Doubtful.
How fat will the next grey bar be? We can’t yet know. Authorities have proven they love to sprinkle more sugar (money) into the system. This is something Treasury Secretary Jane Yellen is doing daily. Next up is the Fed. Lights on!
My current hypothesis is that the Fed and the fiscal authorities will give us more sugar. If I’m correct, a recession will likely be shallow.
Why the Recession obsession? The average decline in the S&P 500 during recessions is approximately 35.8%. That would take us into the mid-3,000 zone on the S&P 500. The last two recessions have given us greater than -50% each. Given that we have tripled up on the same thing that caused the last recession (debt/leverage/Fed policy), the next recession will be equally or more challenging than the last two.
Target Zone for the 10-year Treasury Yield
There is some upside to recessions for those looking to refinance an existing mortgage or buy a new home. That opportunity appears to be approaching.
I’ve drawn some dotted arrows to the right of the yellow highlighted zone, indicating a potential path. The more solid horizontal dotted line in the center of the yellow zone indicates that the 10-year Treasury yield has good technical support at 3.25%, which is my target.
There is a chance it will drop. I’m setting my target zone between 2.50% and 3.25%. Recession likely puts us in that zone.
The yield today is 4%. It touched 3.69% on Monday. Keep watching this chart.
The Yen
When the price line moves down in the upper section of the chart, the yen depreciates. When it goes up, the yen is appreciating. The BOJ wants the yen’s value to be higher. A higher yen hurts the carry trade.
Source: StockCharts.com
This is not a recommendation to buy or sell any security. It is for educational discussion purposes only. Opinions are subject to change. Consult your advisor.
Please see the important disclosures in the disclosures section below.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Random Tweets
Source: @KobeissiLetter
Hussman’s latest – worth the read:
I “like” and “retweet” posts I find interesting. I enjoy X because I can easily follow people I like to keep On My Radar.
You can follow me on X (formerly Twitter) @SBlumenthalCMG.
You can also listen to my podcasts on Spotify, and find me on LinkedIn.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Personal Note: Coach John Wooden and Bill Walton
I asked Susan if she had something motivational squared away I might share with you. And she emailed me the following (you can click on the photo to watch Bill Walton talk about his legendary coach, John Wooden. You’re going to love it, I promise.
Here’s the transcript of Walton’s speech if you’d prefer to read:
Coach Wooden. He lived by his two sets of threes, and he implored us to give it a try.
- Don’t lie, don’t cheat, don’t steal, don’t whine, don’t complain, don’t make excuses.
That covers a lot of ground. And then Coach Wooden had a billion maxims and mantras that he would throw out just the appropriate time. His use of the English language unparalleled. That was his true love.
And so he would say things to us like,
- “Be quick, but don’t hurry,” whatever the heck that means.
- “Failing to prepare is preparing to fail.”
- “Happiness begins when selfishness ends.”
- “Never mistake activity for achievement.”
- “The worst things you can do for the ones you love are the things they could and should do for themselves.”
- “Stubbornness, we deprecate. Firmness, we condone. The former is my neighbor’s trait. The latter is my own.”
- “When everybody thinks alike, nobody thinks. It’s okay to disagree. Just don’t be disagreeable.”
- And then the one that he wrote for me on the day I graduated from UCLA, June 1974 forty-five and a half years ago, “To Bill Walton. It’s the things you learn after you know it all that count.”
That still sits on my desk, but his fallback go to mantra was always the same. He would look at us with a straight face, and he would say he was a very serious guy and took his job with great duty, solemnity, and respect. He would look at us, and he would say,
- “Remember, guys, basketball is just like life. It’s not a game of size and strength, it’s a game of skill, timing and position. It’s not how big you are, it’s how big you play. It’s not how high you jump, it’s where you are and when you jump.”
So while Coach Wooden races through all these positive aspects of our personal foundation, I’m scratching my head. That’s why I’m bald today—I just couldn’t stop scratching my head.
And I would just look at him, and I’d say, Coach, you cannot possibly believe these things that you’re saying, particularly when you tell us that basketball is not a game of size and strength. Come on. Kareem has all the records, Shaq has all the money, and Wilt has 20,000 girlfriends. So, you tell me it’s not a game of size and strength?
And he’d look at me and say,
- “Walton, you’re the slowest learner I’ve ever had. Don’t you realize it’s not about stuff; it’s not about material accumulation? It’s about training the mind to become the champion in everything that you do. But that requires you to play on the teeter-totter of life, leadership and risk and fearlessness, ego, humility, and making that decision and the choice that I am going to make the sacrifice for the greater goals of the team.”
Bill Walton
The teeter-totter of life, risk and fearlessness, humility, and team! Wow!
A toast this week to the late great John Wooden and his late great player Bill Walton.
I’m in NYC on Sunday and Monday for meetings. Really looking forward to another great week.
With kind regards,
Steve
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
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“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”