What the carry trade means to the stock market

I thought I would just go into a bit more detail about the carry trade and what this means to the stock market. The Dollar/Yen relationship is the key. If the yen strengthens against the dollar this is called a carry trade unwind. The yen carry trade (borrow yen cheap, convert to dollars and invest) is one of the prime sources of funding for the U.S. stock market. It is also a very big reason why our market has such high exposure to the carry trade. Many hedge funds are highly leveraged; they get some of that leverage from the yen carry trade. When the yen suddenly strengthens, it makes that trade more expensive, and at some point prohibitively expensive, which requires unwinds of the trade. That means selling stocks with money bought from the carry trade, and it means bonds higher, gold rallies. A rising yen means a weaker Nikkei as we have seen this year. Shinzo Abe unveiled his devalue-the-currency three arrows plan over a year ago and Japan is now in much worse shape now than it was before.

The market in the U.S. did not fall due to the Fed announcement of more tapering. If you remember when they first tapered, the market actually rallied on the news. The problems are coming from soaring repo rates in the emerging markets as a result of the easy money supply being reduced. The money from the QE was going into these markets via the U.S. banking system. In order to make money under the Fed’s zero interest rate policy, banks are engaging in hidden off-balance sheet transactions, including asset swaps, which substantially increase systemic risk. In an asset swap, a bank with weak collateral will “swap” that for good collateral with an institutional investor in a transaction that will be reversed at some point. The bank then takes the good collateral and uses it for margin in another swap with another bank. In effect, a two-party deal has been turned into a three-party deal with greater risk and credit exposure all around.

Central planning failed for Stalin and Mao Zedong and it will fail for the U.S. Fed too. When Nikolai Kondratieff told Stalin that the West would thrive after the depression because capitalism had to go through these cycles of bust and boom as a normal process, he was sent to a Gulag and executed. What the U.S. is doing is interfering with this natural economic process in the same way communism did. This current U.S. monetary policy is Neoliberalism and it will surely fail.

I am not concerned about where the markets or gold will be 12 months from now. All I care about is where the markets are going right now. A lot of people ask me where the market will be in 12 months from now. I don't understand that.

Lets just focus on what we know now.

The Nikkei has broken into a confirmed downtrend today on the weekly chart. I don't know if this is the beginning of a major trend change. We will have to wait and see.

Our market is in confirmed downtrend on the weekly chart.

The U.S, markets are all in confirmed downtrend on the weekly chart. The data this year has been quite soft. I don't see any recovery whatsoever.

That Hang Seng is in a confirmed downtrend. The data coming out of China is weak at best.

The VIX is still above 15 so therefore is in the danger zone.

Gold is in uptrend on the daily chart. That is not to say it can not turn back down from here.