By Anthony Mirhaydari
The complacency that had descended over Wall Street is being swept away by winds from Asia.
A weaker-than-expected manufacturing activity report out of China and the realization that "Abenomics" in Japan isn't working — mainly, the massive devaluation of the yen via quantitative easing by the Bank of Japan — has the Dow Jones Industrial Average testing its 50-day moving average for the first time since late September.
(Back then, the worry was over the debt ceiling, which is poised for a comeback in February as well.)
The catalyst for all this is the yen-carry trade, which has allowed hedge fund types to sell the yen short and use the proceeds to dabble in U.S. and European assets. That's fueled the melt up in stocks since October and has helped push up peripheral euro-zone bonds to ridiculous levels. Consider that Italian bond yields have hit seven-year lows, yet Italian bad loans are up 23% year-over-year for the fastest pace of credit degradation in two years.
Today, the yen carry trade, as represented by the ProShares UltraShort Yen /zigman2/quotes/208659456/composite YCS -0.95% , is collapsing below both its lower Bollinger Band and its 50-day moving average — the most significant downtrend initiation since June. The scramble to cover positions funded by yen carry trades is why the selling is so frantic.
A little more detail on those winds from Asia.
The Chinese PMI Flash Manufacturing Index dropped to 49.6 vs. the 50.6 consensus estimate and the 50.5 reported in December. Any reading under 50 indicates a month-over-month contraction in activity. The index was dragged down by lower domestic demand, which is a problem as Beijing has been trying to simultaneously reduce their economy's overreliance on exports, infrastructure building, cheap credit, and a cheap currency.
With growing concern over the health of the Chinese banking system — as questions brew over the use and solvency of off-balance sheet vehicles of the kind seen here during the housing boom -- a stalling of factory activity couldn't happen at a worse time. Already, there are reports of bank runs underway in some areas.
In Japan, the drop in the yen was encouraged by the assumption that the Bank of Japan was set to unveil an expansion of its quantitative-easing program, perhaps as soon as this spring. That's looking less likely now, as current efforts to weaken the yen to boost export competitiveness has attracted the ire of trading partners, such as South Korea, and has failed to boost wages as Tokyo desired. Instead, food and fuel prices are rising, pinching consumer spending power.
The ultimate end game for Japan, which is heavily indebted and vulnerable to any increase in government borrowing costs, casts a long shadow over the situation should any reduction in the pace of quantitative easing cause turmoil in the Japanese government bond market.
For now, I continue to recommend investors maintain a cautious stance, focusing on the buying interest coming into safe-haven assets like U.S. Treasury bond and precious metals while booking profits in biotech stocks that have been red hot this month. The leveraged Direxion 3x Treasury Bond Bull /zigman2/quotes/209018185/composite TMF +3.73% is up nearly 7% in my Edge Letter Sample Portfolio since it was added on Jan. 10. I just sold Tower Hill Mines /zigman2/quotes/203626403/composite THM -3.32% and Rosetta Genomics for gains of 46% and 18% respectively.
Disclosure: Anthony has recommended TMF to his clients.