Weekly Market Update 8/9/2024

Market volatility continued to rise, but the S&P 500 was able to claw back virtually all of Monday’s sharp decline, the first -3% one-day drop for stocks since September 2022.  Last week’s concerns around the Federal Reserve, slowing economic growth, and tensions in the Middle East continued, but were exacerbated by the swift reversal of a popular trading strategy involving the Japanese yen, known as the carry trade.  As a result, the S&P 500 has seen a 1% move (up or down) during six of the last eight trading days and has pulled back roughly 5.5% from the all-time highs it reached in mid-July. 
 
However, it is important to note that corrections are not uncommon and per data from BofA, since the 1930s, the S&P 500 has on average registered 5% selloffs three times a year.  Furthermore, per Goldman Sachs, the median S&P 500 return following such declines is +6% over the next three months with a positive return 84% of the time.  Next week will be a busy one for economic data headlined by the CPI report on Wednesday and retail sales for July on Thursday.

WHAT IS A CARRY TRADE?

At its core, a carry trade is a strategy where a trader attempts to profit from different interest rates across countries.  For example, the yield on the 10-year US Treasury is around 4%, while the yield on the Japanese equivalent is well under 1%.  Therefore, a trader would sell Japanese yen to buy/borrow US dollars and then invest in the higher yielding US Treasuries to pocket the extra yield.  However, such a trade only works if the currency funding the trade, in this case yen, stays relatively stable. 

Unfortunately for carry trade enthusiasts, the exact opposite occurred, and the yen strengthened relative to the US dollar by roughly 10% in a single month, a massive move for foreign exchange markets.  As a result, FX traders scrambled to unwind these carry trades and it created an avalanche of knock-on effects around the world, most visibly in Japan with the Nikkei falling over 12% on Monday, its worst day since “Black Monday” in 1987.  Fortunately, it appears as though the fallout from these carry trades is largely over and hopefully investors can return to focusing on the economy instead of market structure and trading strategies.

Ian G. Browning, CFA
Managing Director, Investment Strategies | Shareholder

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