|Dow||-51.28 to 17,801.20|
|S&P 500||-0.49 to 2,059.82|
|Nasdaq||+25.78 to 4,766.47|
|10-YR Yield||-0.037 to 2.22%|
|Gold||+$35.20 to $1,230.10|
|Crude Oil||+$0.66 to $63.71|
“Carry Trades” are dominating market action. Not just here. Not just in stocks. In virtually every asset class around the world.
But now, some troubling tremors are starting to emerge – and that could change the game!
So let’s address your first question right up front: What the heck is a carry trade?
Think of it like banking. A bank’s goal is to raise money cheaply from depositors like us, then take that money and loan it out at a higher yield to someone else. Paying out 1 percent on a CD, and loaning it out at 5 percent to a small business is basically a way for the bank to earn “positive carry” of 4 percent.
|China’s markets were hit hard, and other markets sold off in sympathy.|
Things are more complicated in the global markets. It’s not just banks with a seat at the table, and it’s not just CDs or business loans. It’s investors of all sizes – all trying to borrow cheap money from a wide variety of sources, and investing that money in a wide variety of higher-yielding assets.
The strategies involved can be incredibly complex. But lately, some of the biggest carry trades have been those taking advantage of cheap yen and cheap euros. That’s because the Bank of Japan and European Central Bank have been doling out free money like Halloween candy.
So as part of this common carry trade, global investors will …
1. Borrow cheap yen and euros (and to a lesser extent, borrow in many other currencies) …
2. Sell those currencies and convert their funds into dollars …
3. Then buy dollar-based assets that yield more, largely because the U.S. Federal Reserve has been talking tougher than its overseas counterparts.
That process has helped drive U.S. stock prices higher and higher in recent weeks. There has also been a negative side effect on commodities. Commodities often trade as “contra-dollar assets” – meaning they fall in value when the dollar rises. With the dollar surging, it’s been a bloodbath in gold, silver, copper, crude oil and other resources markets.
So what’s the problem? Can’t we all just sit back, buy U.S. stocks, short the yen and euro, dump energy and gold, and retire as millionaires?
Maybe for a while. But eventually, the rubber band gets stretched too far. Everyone and his sister will put the same trades on, and you get to the point where assets are ridiculously mispriced. When that happens, even the smallest bit of contrary news can lead to furious counter-trend rallies.
|“The Bank of Japan and European Central Bank have been doling out free money like Halloween candy.”|
I’ve seen it happen before many times in my career, and my antennae have been up recently, especially in the currency markets. As much as I think Japan and Europe have major problems, and the U.S. is in better economic shape, the yen and euro have gotten wildly oversold and the dollar has gotten severely overbought.
That means you have the preconditions for a sharp adjustment in place. Then overnight, China’s Shanghai Composite Index reversed sharply and dumped more than 5 percent on record-high trading volume of $128 billion. That was the worst one-day market rout in a half decade for a market that had been rising and rising despite weak, underlying economic fundamentals.
Other frontier and far-flung emerging markets sold off in sympathy, and the Japanese yen launched a sharp rally. As a matter of fact, the yen earlier staged the biggest rally since the spring. Gold and silver have also been seeing a “stealth” rally, and so have agricultural commodities.
Maybe this is a short-term thing. Maybe it’s just a small correction, and nothing more. But it’s worth watching whether this turns into something bigger. Because carry trades are great … until the moves get so large that the markets can’t carry their own weight anymore!
So let me know your thoughts. Have you heard of carry trades before, and does the potential reversal of those trades worry you? What do you think about the yen, the euro, and the dollar? Have we gone too far too fast, leaving us open to a big correction? Or do you think those moves have further to go? Finally, do stock market sectors like energy and gold look attractive to you after the beating they’ve taken in the past several months?
You know the drill: Hit up the Money and Markets website add your comments, and get the conversation going!
|Our Readers Speak|
Boy did my column on the problems at McDonald’s (MCD, Weiss Ratings: C+) strike a nerve! It seems like many of you think the real issue is the quality and healthfulness (or lack thereof!) of the food, plain and simple.
Reader Chloe shared this succinct observation: “I lost the best friend I ever had (a double cheeseburger) when they started using pink slime ‘meat.’ I can’t get past that. And the prices aren’t comparable, either.”
Reader Marne expanded on that theme, saying: “McDonald’s has historically been a very successful company, but will need to reinvent if it is to survive. The reason is that there is increased awareness of the negative effect that refined, processed foods and animal products have on health.
“The Baby Boomers are discovering this, and getting educated on changes in diet that can prevent disease and improve health and longevity. Very influential group, those Boomers – huge numbers, and very willing to spread the word.”
Reader Dave R. piled on as well, saying: “It’s primarily their food. Yeah it’s 100% real beef, BUT it’s pink slime, chicken slime. It’s just junk. McD’s is more interested in PROFIT than quality of product.”
Finally, Reader Holly added the following: “I can really agree with this article. I have two teenage daughters and one teenage son. McDonald’s used to be a ‘Road Trip’ favorite. Not anymore! The kids want to stop at places like Chipotle Mexican Grill (CMG, Weiss Ratings: B).
“‘Yuck’ is often associated with McDonald’s and other fast foods … Their decisions are so much better than mine used to be. I am glad that fast food is losing its grip on our young sailors!”
Well, there you have it folks. Some pretty damning condemnation of the things McDonald’s is doing and the food it’s selling. If you want to weigh in, definitely use the website to share your thoughts – on fast food, healthy eating, or anything else I’ve discussed here!
|Other Developments of the Day|
Over the past few years, the Fed has basically outsourced its communications operation to Jon Hilsenrath at the Wall Street Journal. Whenever it wants to signal a policy change in order to keep Wall Street from freaking out, it appears to “plant” a story in the Journal, using him as the conduit.
Sure enough: Just a few days before the next policy meeting on December 16 and 17, the Journal is reporting on the front page of its website that “Federal Reserve officials are seriously considering an important shift in tone at their policy meeting next week: dropping an assurance that short-term interest rates will stay near zero for a ‘considerable time’ as they look more confidently toward rate increases around the middle of next year.”
Stop me if you’ve heard this one: One of the largest U.S. mega-banks is racking up billions MORE dollars in legal costs and charges. This time, it’s Citigroup (C, Weiss Ratings: B+). The bank admitted it faces $2.7 billion in added legal costs and $800 in charges in the fourth quarter – costs stemming from forex, interest-rate and money laundering investigations and rules.
*Talk of canceled, multi-billion-dollar energy projects. A five-year-low for crude oil prices. Surging yields and falling prices for energy sector bonds, leading to talk of rising defaults.
The pessimism is so thick, you can cut it with a knife. Which may be exactly why you want to start buying. Just a thought. What say you?
Verizon (VZ, Weiss Ratings: B) and AT&T (T, Weiss Ratings: B) got pasted today after Verizon warned that wireless price wars are putting pressure on its profits.
Funny thing is, my household is in the process of switching over from separate AT&T and Verizon plans to a Sprint (S, Weiss Ratings: D+) family plan because Sprint’s deals are just too juicy to pass up. We anticipate saving anywhere from $100 to $150 PER MONTH for making the move … even after factoring in the iPhone 6 upgrades we’ll get as part of the package.
It’s worth noting that I’ve been with AT&T for several years. My wife has been with Verizon for ages, too. But they simply wouldn’t or couldn’t match the competition, and my wife and I can put that money to much better use elsewhere. So tough luck T and VZ – you lost customers who have paid you thousands of dollars over the years!
If you have any comments on these news stories, or others you’ve stumbled across, hop on over to the website to weigh in. I read as many of the remarks as I can, and I know your fellow investors appreciate them.
Until next time,