Are Markets Exploding?

August 9, 2024

Dear subscriber,

Let me start this week's issue with a story from the most talented financial journalist of today, Michael Lewis.

Lewis has written books like Liar's Poker, The Big Short, and Going Infinite. In my view, they're required reading for pretty much anyone in the financial markets.

But his tale of Iceland's exploding Range Rovers is one of my favorite stories of his...

See, Lewis traveled to Iceland in 2008 to study the collapse of the country's banking system.

Shortly after his arrival, while settling into his hotel room, he started hearing what sounded like repeated explosions outside.

He tracked down an Icelander to see what all the noise was about. The Icelander told him, "There's been a lot of Range Rovers catching fire lately."

The Icelander then explained that folks were blowing up their Range Rovers to collect the insurance money. (Yes, times were that tough.)

Iceland had become a huge banking center in the late 2000s. As an official from the International Monetary Fund explained to Lewis in 2008, "Iceland is no longer a country. It is a hedge fund."

Banks – and their assets – grew at unprecedented levels. And they were lending money to Icelanders to buy stocks and real estate... which meant stock and real estate valuations also rocketed higher. From 2003 to 2007, the country's stock market grew nine times over.

Iceland's residents were getting rich. And its currency, the krona, was rising.

Still, Icelandic consumers faced steep interest rates of 15.5%. Eventually, people found a workaround...

Instead of borrowing kronor at 15.5% interest, people borrowed in Japanese yen at 3% interest.

Meanwhile, the krona kept rising enough to cover even the 3% borrowing cost. It was, quite literally, free money.

Then Iceland's entire banking industry collapsed in 2008 during the global financial crisis. It took down the krona and the Icelanders' cushy financial-sector salaries with it.

As Lewis explained in a 2009 Vanity Fair article about his trip...

Now many Icelanders – especially young Icelanders – own $500,000 houses with $1.5 million mortgages, and $35,000 Range Rovers with $100,000 in loans against them. To the Range Rover problem there are two immediate solutions. One is to put it on a boat, ship it to Europe, and try to sell it for a currency that still has value. The other is set it on fire and collect the insurance: Boom!

This is a carry trade gone bad.

Two weeks ago, I wondered why markets remained so calm given the political turmoil in the U.S.

Now volatility has returned to the market, but it was the Japanese government that kicked it off.

You may have read an explainer or two on the Internet this week about the Japanese carry trade. As often is the case in finance, it sounds complicated, but it's based on a simple idea.

A carry trade is when you borrow money from a country with low interest rates to then invest it in the assets of another country with a higher rate of return.

If this trade is available to you, you should borrow as much money as possible to pour into the spread. Because if you can borrow money at 1% and invest it at 5%... you make 4%.

You'd make $4,000 on a $100,000 investment. But you'd make $4 million on a $100 million investment. Don't waste free money on a Chevy Malibu. Go for the Range Rover.

In the Japanese carry trade, U.S. financial institutions (read: hedge funds) borrowed in Japan's currency, the yen, then converted their yen into dollars.

They then invested that money into other assets... That could be as simple as U.S. Treasurys or riskier assets like stocks.

But the Bank of Japan announced a surprise hike in interest rates on July 31. That sent Japanese borrowing costs and the value of the yen up.

Since there was so much leverage involved, carry traders wanted to get out fast. That meant they had to sell the assets they had invested in... sell their U.S. dollars... and buy yen to pay back their borrowing.

But this only exacerbated the problem, driving U.S. assets and the dollar down and the yen up.

That's when panic selling takes over. And it's why we saw a 3% drop in the S&P 500 on Monday.

These things happen from time to time. When they unwind, they can drive markets down as traders try to sell their positions. Most of the time, the damage is contained.

In rare cases, the damage can spread further... The famous collapse of Long-Term Capital Management came when the hedge fund used extreme leverage to profit from small differences in bond prices.

There's no single stat to show you what carry trades hedge funds hold or how big they are. But JPMorgan Chase now estimates that 75% of global carry trades have now been unwound.

It looks like the turmoil from this yen carry trade has passed.

But it's also important to note that the market decline is due to much more than the yen carry trade falling apart...

That was a real factor in Monday's big drop. But there are other bigger, more important factors driving the market's 6% decline since its peak on July 16 – including weak economic data, growing recession fears, and falling Treasury yields.

This is not the biggest drawdown I've invested through. But I can tell from speaking with our readers that this week's action has given investors the willies. And it's worth taking the time to discuss.

Put simply, there are a lot of things to worry about in stock valuations and the economy. Recession risks are rising. But there's a lot of opportunity, too.

That's why some of our top investment minds at Stansberry Research convened for an in-depth conversation to walk through it all. I sat down with founder Porter Stansberry, partner Dr. David "Doc" Eifrig, and senior editor Whitney Tilson to make sense of it all. Over the course of this hourlong recording, topics discussed included...

What's next for tech stocks, particularly the Magnificent Seven

Why Porter sees a potential long and deep recession coming
One sector that Porter and Doc believe will benefit from artificial intelligence
What the "Buffett Indicator" says about the market's current valuation
How to manage your portfolio today
What corner of the market Whitney is looking at for undervalued opportunities

You can watch our Emergency Market Briefing, entirely free, right here...

What Our Experts Are Reading and Sharing...

A wise investor looks through the market noise and focuses on high-quality businesses. On a new episode of the Power Law Investing Podcast, Porter Stansberry and Whitney Tilson do a deep dive on McDonald's (MCD) – one of the world's greatest brands. You can listen to the episode at Porter & Co, YouTube, and Spotify.

Michael Lewis first told the story of exploding Range Rovers back in 2009. You can check out his article in Vanity Fair here and his interview with NPR here. Lewis will be the keynote speaker at the 2024 Stansberry Conference & Alliance Meeting in Las Vegas this fall. And tickets to the event are selling fast. So if you haven't reserved your seat yet, click here.

Elliott Investment Management is a successful hedge fund. It's also an aggressive one. (It once seized an Argentinian naval vessel because Argentina owed it interest on government bonds.) In a recent letter to investors, the fund warned that AI stocks are in a dangerous bubble. It stated that AI products are "never going to be cost-efficient, are never going to actually work right, will take up too much energy, or will prove to be untrustworthy." The letter was leaked to the Financial Times and has been reported on elsewhere.

**New Research in The Stansberry Investor Suite...**

If you're worried about a recession, you want to invest in defensive, recession-proof businesses.

If you're more optimistic, you may prefer to be more aggressive and may favor stocks growing sales and earnings per share.

If you're unsure about what's going to happen next... then you'd want some sort of magical stock that's able to reward investors in both types of markets.

For Stansberry Investor Suite subscribers, we're isolating exactly that kind of stock today...

As part of your subscription, you get access to Stansberry's Investment Advisory's six carefully crafted Monitors. These cover key sectors and strategies that Stansberry Research believes are the most rewarding for your investment dollars.

The six Monitors you get access to are the Capital Efficiency Monitor, the Insurance Value Monitor, the Trophy Asset Monitor, the Global Oil Value Monitor, the Global Elite Monitor, and the Magic Stock Monitor.

The Monitors guide our research and allow subscribers to dig deeper into their own ideas.

This month, senior analyst Mike DiBiase highlights a selection from our Magic Stock Monitor.

Our Magic Stock Monitor uses a set of extremely strict criteria to find stocks that produce high returns, but with little volatility for investors.

Magic Stock requirements are so stringent that it's rare for a stock to qualify. It's why we also keep a Magic Stocks Watch List for companies that are close to meeting our criteria.

The stock Mike shares today has had incredible performance over the past two decades. It's up nearly 200% just since 2019.

This isn't a hot growth stock. Nor is it driven by the AI mania. It's actually a pretty boring company. But it has a special way of rewarding shareholders that tends to drive its stock higher. And it's a simple strategy this company will continue going forward...

Investor Suite subscribers can read all about it in the Magic Stock Monitor update here.

If you don't already subscribe to The Stansberry Investor Suite – and want to learn more about our new special package of research – click here.

Until next week,

Matt Weinschenk
Director of Research