🎙️ Carry Trade Blowup

Market breadth keeps expanding.

Today, 38% of S&P 500 companies are outpacing the benchmark itself, up from just 25.2% in late June. (The historical average is 48%.)

That evidence of breadth expansion runs counter to what strategists and pundits on TV have said in recent months. As today’s chart below illustrates, a growing number of S&P 500 stocks are outperforming.

— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• Thoughts on the carry trade blowup

• Detailing today’s housing market

This, and more, in just 5 minutes to read.

Chart of the Day

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In The News

🤯 Carry-Trade Blowup Haunts Markets Rattled by Rapid Unwind

Remember the global market meltdown? Just one week ago, markets registered one of the most volatile days ever. 

After the dust settled a bit, the upheaval last Monday now appears to have been a short-lived panic triggered by a minor policy adjustment from the Bank of Japan and renewed concerns about a potential U.S. recession. The rapid onset and equally swift dissipation of the market turmoil highlight the vulnerability of markets to a widely used hedge fund strategy that has been used to finance hundreds of billions of dollars in bets across global markets.

Trading away: The strategy, known as the yen carry trade, involves borrowing in Japan, where interest rates have remained exceptionally low, and investing in higher-yielding and speculative assets worldwide, like Mexican bonds, Nvidia stock, or even bitcoin. The trade became increasingly profitable as the yen continued to weaken, making the loans cheaper to repay and amplifying returns.

• But the trade’s sudden unwinding drove a rebound in the yen and a rapid exodus from equities and other currencies. That triggered a cascade of asset sales as traders scrambled to meet margin calls. The Japanese stock market felt the pain: The Nikkei 225 index endured its most severe one-day decline since 1987, plummeting over 12%.
  

• "The yen carry trade remains the epicenter of everything in markets right now," one strategist told Bloomberg. 

The catalyst? The Bank of Japan's decision to raise interest rates. Though the benchmark rate is still only 0.25% — the lowest among industrialized nations — the increase was enough to challenge the long-held assumption that Japanese borrowing costs would remain near zero indefinitely.

Why it matters:

Estimating the full extent of the yen carry trade is challenging because of the lack of official data. Yet some estimates suggest that roughly $1.1 trillion was invested in the strategy.

• While some analysts believe that the majority of the unwinding has already occurred, others anticipate further unwinding that could drive the dollar-yen exchange rate down to 100, a more than 30% decline from recent levels.
  

• "Further carry-trade unwinding seems likely, but the most significant and destructive part of this bubble burst is now behind us,” another strategist told Bloomberg. 

History: The strategy's roots can be traced back to the 1990s, when Japan slashed interest rates to zero following a real estate crash. The Bank of Japan even pushed rates below zero in 2016, further incentivizing the carry trade as other central banks raised rates to combat post-pandemic inflation.

Final word: Said one Bloomberg strategist: “The truth is that the yen is still deeply undervalued, and as the Fed gets going with its policy loosening, those carry trades still left on look increasingly wobbly. But Monday’s episode was entirely about the markets and it isn’t about to cause an adverse feedback loop for the real economy.”

Read more

More Headlines

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🏠 Housing for Boomers vs. Millenials: Who Had It Worse?

This isn’t exactly a wonderful time to buy your first home. 

The housing market is giving millennials and Gen Z all kinds of fits, echoing baby boomers' difficulties in the 1980s. Home-buying affordability recently hit its lowest point since September 1985 — 39 years ago — creating a frustrating situation for young adults seeking their first home, according to a Wall Street Journal report.

Boomers vs. Millennials: In 1985, when many baby boomers were in their prime home-buying years, high mortgage rates were the main obstacle. Today, while mortgage rates are lower at around 6.5%, home prices have skyrocketed by more than 50% since 2019, making affordability a major issue.

• The contrast in consumer sentiment is stark. In September 1985, 72% of consumers believed it was a good time to buy a home. In June 2024, only 12% shared that optimism.
  

• The financial requirements for homeownership have increased dramatically. In January 2021, a family needed an income of $49,152 to afford the median-priced single-family home with a 20% down payment. By June 2024, that required income had more than doubled to $110,544.

Aging: The age of first-time homebuyers has also increased. In 1984, the typical first-time buyer was 29. By 2023, that age had risen to 35. Homeownership rates among millennials lag behind those of baby boomers at the same age. About 40% of millennials own homes at age 33, compared to nearly 60% of baby boomers. And a growing number of new homeowners don’t have kids. 

Why it matters:

We’ve heard younger Americans complain about housing affordability over the last few years, and these numbers put evidence about their worry.

That’s not all. While buyers in the 1980s had access to more flexible mortgage options, today's buyers face stricter lending standards implemented after the 2008 financial crisis. (Now, to be sure, they do benefit from a wider range of down-payment assistance programs.)

Plus, other homeownership costs have skyrocketed. Take property taxes, home insurance, utilities, and home improvement costs. 

Lack of supply: A key difference between the 1980s and today is the supply of homes. In 1985, 1.7 million new housing units were built, compared to 1.4 million in 2023. The current housing inventory is 12.5% below the average level from 2017 to 2019, further exacerbating affordability issues. 

• And, as we’ve covered, many homeowners today are locked in low mortgage rates, so they’re unlikely to move anytime soon, adding to the gridlock.
  

• Economists suggest that while affordability may improve slightly if mortgage rates decrease, relief for homebuyers will require a major increase in home construction.

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Quick Poll

On Friday, we asked: Are you currently invested in any penny stocks? If so, why?

— More than half of respondents said they have never invested in penny stocks. “These companies are pushing the limits to stay afloat. Valuations are horrible for a value investor. Stay away from these high-risk, underperforming companies,” one investor said. “Doesn't even cross my mind to invest in those turds," said another.

— Among investors who do hold penny stocks, one said: “Great unknown companies with solid balance sheets and growing cash flows.” Another: “Belief in the company's mission and guided by my personal religious and political beliefs.”

— Other answers included: “Followed some bad advice. But won’t make that particular mistake again.”

See you next time!

That's it for today on We Study Markets!

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