Stock Market Strategy: Liquidity, Yen Carry and the New Paradigm

A paradigmatic shift in market behavior occurred after the collapse of 2008. The commonly accepted drivers of market direction, most especially economic cycles, no longer applies in this post apocalyptic financial farce. In fact, constant Fed / Government intervention and outright manipulation has produced a parallel universe where “good” economic news is bad for the markets and “bad” economic news is good for the markets.

Liquidity is the key factor an investor must follow. All else on the financial news wires serves only as a cloud to distort financial vision. The “bad” equals good paradigm in force today exists because “bad” leads the Fed to increase liquidity which inevitably finds its way into the commodity and equity markets. To argue this obvious logic, to pretend economic growth is or will be good for the markets evidences an astonishing lack of understanding. Trying to manage money today based on the understanding of past economic cycles is akin to using an abacus in a world run by supercomputers. By the time you are done sliding beads the equation has changed a infinite amount of times.

Speaking of the equation, the Yen carry trade is perhaps the most important and volatile component. A constant and wary eye must be kept on this liquidity spigot. Any and every world event that raises the fear gauge and upsets this apple cart leads to immediate suffering in the commodity and equity markets. Take a look at the chart below. Said chart is a three month graphical representation of the Yen carry trade in terms of the Australian $. You will see the dramatic unwind that occurred in March during the earthquake/Tsunami scare. Investors will remember the simultaneous swift selloffs in world markets….


…Yesterday, we experienced the same carry unwind leads to equity / commodity rout.  The 5 day AUD/JPY chart below illustrates the precipitous drop from Monday through Tuesday:


Zero Hedge explains….

All Carry Unwinding Fast – General Collateral Hits Unprecedented 1 Basis Point

While the sell off in stocks and commodities following Goldman’s latest two-ply hit job had left the FX carry alone, it appears that even the funding desks have given up and are now dumping the core carry pairs, sending the JPY once again back to the intervention border. As the chart shows all FX carry pairs just got trampled, which in the perverse vicious loop that the market has become courtesy of peak leverage, means further weakness across all assets is likely imminent.

…So, until further notice watch the events unfolding in Japan closely. Expect negative events to unsettle the carry trade and so rock the equity / commodity markets in the short term. However, remember that “bad” equals “good” in this crazy world. Remember, each world crisis will be met with an equal or greater force of liquidity from central banks. This paradigm means fiat currency will continue to deteriorate sending commodity / equity prices higher. These are the new rules of the match. Don’t complain about fairness or waste time trying to call the top. Instead, use the knowledge to profit and defend your portfolio accordingly

About Bret Rosenthal

Interpreting the news that moves markets. Principal of RCM, LLC, and founding partner of the Fortune's Favor Family of Funds
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