Market Chaos Will Lead to Improved Stock-Picking Opportunities
The market will stay volatile in the near term, but the shakeup will eventually lead to great new opportunities for select stocks.
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On Monday, U.S. markets suffered their worst day since the raging bear market in 2022. Japan, which had its biggest crash since Black Monday in 1987, fell 12% as the carry trade unwound but then rebounded more than 9% last night. A bounce in European stocks fizzled out quickly Tuesday morning, and there is a minor rebound in U.S. markets early on Tuesday.
Many market participants are worried about further unwinding. According to JPMorgan JPM, only about half of the carry trade has been unwound so far. Because of very low interest rates in Japan for many years, there is a giant yen carry trade. Traders borrow cheap funds in Japan and then invest in higher-yielding investments in other currencies, such as the U.S. dollar.
As long as the yen doesn’t rise in value versus other currencies and Japanese interest rates remain low, it is a low-risk opportunity, but the yen spiked higher, and now there are massive losses in this trade. It is going to take time for this to unwind, and there will be a ripple effect as it is done.
In addition to the carry-trade drama, there has been a sudden shift in economic sentiment. Fear of inflation has morphed into fear of a recession, and now there are outcries that the Fed has made a policy mistake by not already cutting interest rates. The change in economic sentiment occurred almost overnight, and the market is struggling to reprice what it means.
Expectations of a rate cut prior to the next scheduled meeting in September have skyrocketed, but it is not at all clear what the Fed might do. There is little question that rate cuts are coming and will be substantial, but will they be the cure for all the economic ills and put the market back into a strong uptrend? Some analysts believe that rate cuts will not be an easy solution.
The other problem that the market is grappling with is a reassessment of the AI trade. Big-cap technology has boomed on the promise of AI, but it has become clear that massive capital spending is still needed to implement it, and the positive financial results will take time to develop. Warren Buffett’s dumping of some expensive Apple AAPL stock isn’t helping matters.
It is a mess out there, and it will take time for market participants to sort it all out. Investors Business Daily suggests market exposure of just 0-20% while waiting for technical conditions to improve.
The good news is that the market needed a good hard shake to reset valuations and create new opportunities. The prime theme for the past couple of years has been very narrow big-cap strength that created the illusion of a bull market while most stocks did not participate. That started to correct recently with some outperformance in the Russell 2000 IWM, but that was thrown into disarray during the recent carnage.
Much of the market is not wildly overvalued, and there are many stocks that will benefit from interest cuts, and therein lies great opportunity. We are currently in the teeth of big macro moves, and that means that many stocks are being jerked around without any regard for their value. Eventually, the big index-driven swings will fade, and it will be time to sort through the wreckage and find the nuggets of opportunity in individual stocks.
I’m highly optimistic about the opportunities that lie ahead, but we need to be patient at this juncture and let the corrective process proceed. There will be some trading opportunities due to high levels of volatility, but we will need to wait a while before we can pick quality stocks and build longer-term positions.
At the time of publication, Rev Shark had no positions in any securities mentioned.
