Right you are Freshmilk, if you keep betting black eventually you'll hit it and today I hit it: On 2/15/07 I stated: "although the US stock market has made breathtaking gains lately, the spread between the highs and lows is getting really narrow. I've noticed on smaller scales that when this happens that significant downturns can occur." Today my prediction became fact resulting in a significant downturn (in relation to the prevailing spread between highs and lows). At one point (3pm EST) the Dow dropped 300+ points over the span of ten minutes for a daytime low of -546 points. Jim Cramer stated it like this: "You didn't even have time to panic. The system failed us, breaking down too fast for you to panic." I also noted on May 18, 2006 while musing about the 1987 crash that "in looking at what the market is doing now, I see it headed down sharply and not recovering any time soon [and I would] not be surprised if we see a day in the not too distant future when the market tanks heavily in a one or two day period."

And it appears that the Yen Carry Trade may have held some of the blame (take that BK!). In my previous post I stated that if the yen rises, investors who had been relying on the value of the yen to stay low will have to suddenly unwind from their investments (sell dollar investments like the stock market and buy yen) if the price of the yen goes up, which will push the price of the yen higher still.

Bloomberg.com reported that "The yen rose the most in more than 19 months against the dollar amid a sell-off in U.S. stocks and as investors shunned emerging-market assets, prompting an unwinding of trades betting on a decline in the Japanese currency. The yen rose 2.3 percent to 117.94 against the dollar at 4:15 p.m. in New York, from 120.66 yesterday."

And this from the New York Times, "There was a sharp rise in the Japanese yen. People are unwinding the carry trade,” Mr. Barbera of ITG said of Tuesday’s trading. "In that trade, which has been very popular with hedge funds, traders borrowed yen, at very low interest rates, and then invested the money in assets in other countries. Now you try to get closer to shore, traders have sold investments and used the proceeds to repay their yen borrowings."

So watch this closely, that 2.3% rise in the yen probably had an effect in today's sell-off and it may get worse due to the viscous circle nature of selling dollar assets to buy back yen to pay off loans and given the trillions of dollars caught up in this strategy this will have a profound effect on the market.

To answer BK's assertion that the yen carry trade is like other signals that the sky is falling, I can only say that I've looked at some of these other signals, like copper, and they haven't caught my eye. Copper, while historically has been a good bellweather for times of growth, copper is now caught up in the whole big liquidity bubble that all assets are experiencing and therefore is not behaving in exactly the same way as it has in the past. I'm stating that the yen carry trade is special in this regard due to the huge amounts of money involved, the sudden unwinding that will have to occur and because I believe that the low valued yen is the very source for the global liquidity bubble.

So my prediction is that the sell-off isn't over. The uptrend that we had for the last 8 months is over and a downtrend just started. I'll go out further on a limb and say that this is the start of the big drop. The price of the Dow and other markets may pop back up to yesterday's level briefly (although I really doubt it given the brick wall that it hit today) but for the most part we've seen the stock market's heyday. I say this from a technical charting perspective and a fundamental one; there's too much liquidity, which has led to speculation and now that liquidity is starting to shrink (because the speculation is imploding). True, for the past 90 years the market has gone up (interspersed with occasional interludes of downward prices). We've experienced the largest bull market in history, but all bull markets come to an end and bears eventually take over. If we're talking about hundreds of years then yes, all markets eventually go up overall, but we're due for a huge bear market--much larger than anything we've seen since and including the Great Depression. I believe we've actually been in a bear market since 2000. It doesn't seem like it because the Dow is higher now (at least it was yesterday) than it was in 2000. That doesn't mean it's not a bear market, it's just a really, really big bear market, which is just getting started. We just got done with the pullback (in this case a large 3 year upward move), contrary move, wave B (in Elliot Wave parlance), whatever you want to call it and we will now resume the downward path that was started in 2000 and unlike 1987's October crash, this drop today will not be a bump in the road to higher gains but rather the talking skull and crossbones located on an arch above your E-ticket boat raft. He talks to you and you can just hear him over the sound of ever louder rushing water: "No fear have ye of evil curses, sez you? Ahhh... properly warned ye be, sez I ... Who know's when that evil curse will strike the greedy beholders of this bewitched treasure. Dead men tell no tales."

Checking through the annals of Lowbar history, I found that Howie first predicted doom for U.S. Stocks, most notably the Dow Jones Industrial Average (from this point forward referred to simply as "the Dow" for purposes of this discussion), on June 17, 2005. At the time of this prediction, the Dow was around 10600. The Dow went on to tack on a very meager 1% gain in the remainder of 2005, then a healthy 16% gain in 2006. Last Friday afternoon, it closed at 12767.57, a gain of 20.5% in 20 months. Any reasonable investor would be quite pleased to have a net return like that over a 20 month period.

Like natural disasters, sports outcomes, and the end of the world, if you keep making predictions, eventually you will be right. In the case of studying the stock market, there are a number of alarmists who get hung up in one or two "key" indicators that are said to be surefire signs of IMPENDING DESPAIR. The price of copper (now regarded by most to be an obscure indicator) and the Yen carry trade are two common ones. But if you want to follow the lessons of history, there is one basic one:

Over the long term, the market fluctuates up and down on an overall uptrend. Occasionally, there are significant and meaningful pullbacks...and a very significant one just occurred from 2000-2003. While there are always bearish blowhards and "key" indicators of exaggerated importance (just like there were people saying to stay out of real estate in Northern VA in 1999...WAY too inflated, right?), a bet against the Dow, particularly this soon after a "correction" of over 20%, is a bet against the house...in other words, a losing proposition much more often than not.

But keep predicting the doom, noble Howie, and eventually you'll see something that makes you feel like you were right all along. I am enjoying the returns on my meager invested pennies while I can.

If you haven't heard about the yen carry trade I urge you to learn about it. Basically the idea is that because the Bank of Japan loans yen at close to zero percent, investors are able to take that cash and convert it into something that earns interest, like say US Treasuries at 3%. The yen carry trade has been in effect for about eleven years and people are pretty used to it. At the yen's low levels the carry trade will continue but if the yen were to rise against the dollar then hedge funds would be forced to unwind from their many other positions. This would mean that they would have to sell their US holdings in dollars to buy yen and this would push the value of yen up higher causing more investors to be forced to liquidate. This would also spell the end to the US's ability to sell bonds since they would not be as attractive as they had been. Since trillions of dollars are wrapped up in this carry trade other markets like the US stock market will also feel the impact. As I look at the charts for the US dollar to Japanese Yen it does indeed look like the yen is set to go higher. The other thing I've noticed lately is that although the US stock market has made breathtaking gains lately, the spread between the highs and lows is getting really narrow. I've noticed on smaller scales that when this happens that significant downturns can occur.

More info on the yen carry trade can be found here:

Carry Trade to Unwind: Market Crash Alert

Bloomberg: Japan's Boom May Explode Yen


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