Date: February 21, 2020

Coronavirus Back on Top. Japanese Yen Causing Dislocations.

Stocks had been trading pretty much immune to the daily headlines regarding Corona even though everyone had known there would be economic impact. It’s like everything else in the markets. It doesn’t matter until it matters and then it matters in a huge way. That was best seen in 2005, 2006 and 2007 with the financial crisis. Don’t misunderstand; I am not saying that Corona is anything like the financial crisis.

On Thursday and at least the morning on Friday, stocks are red and under pressure with the media blaming Corona. I get it. They have to blame something. I think the quiet culprit has been the Japanese Yen which has collapsed of late against the dollar as you can seen below.

Most people don’t know anything about the yen nor do they care. In the modern era, it has been a safe haven currency in times of financial stress, like 2008. For decades, there has been a common trade called the yen carry trade put on by big money more often than not. In short, investors borrow money in yen because rates were essentially 0% and then convert to another currency, usually the dollar, and invest that money in treasuries, MBS or even stocks. There is a mathematical relationship which investors use to control position size and risk. All goes swimmingly until the currency makes a huge move.

On Wednesday and Thursday, the yen made a huge move, like it has before, but the magnitude may have caused portfolio managers to take quick action without regard for price. Market dislocations catch many off guard. I am just speculating.

Anyway, stocks are clearly under pressure. All year, I have discussed the historic level of greed and euphoria in the market. Stocks only needed a spark to begin a pullback. I don’t think this will be a big one, but wiping out all of 2020’s gains would not be surprising. Mid and small caps have trailed for a long time, but they are outperforming now, including closing higher on Thursday with the market down.

Semis and tech getting hit the hardest. Lots of constructive action elsewhere. Defensive groups at or near all-time highs. Biotech looking good. Even materials look like they want to go up shortly.

It’s easy to not want to own a lot going into a weekend with Corona hanging out there. What if it doesn’t go away in the spring? What if China manufactured it in its bio-weapons lab in Wuhan? Lots of unknowns that won’t be known for a while. In a worst case scenario, this could be the catalyst that tips the globe into recession.


Paul Schatz, President, Heritage Capital