Due to the huge moves in nearly every market and asset class, the structure of today's column will be a little different. First off, I will try to do justice to the horror show that was the Japanese equity market last night. (I don't mean to minimize the human suffering and chaos that is occurring there, but finance and economics is what this column is supposed to be about.)
Japan's market opened under pressure, and when prime minister Kan suggested that the radiation problem was not contained, all hell broke loose. The Tokyo Stock Exchange has various kinds of circuit breakers and, as a consequence, that market quickly reached the point where it was not trading, with all the action spilling over into the futures market in Singapore, where those kinds of trading limits don't exist. At the height of the panic, the Japanese futures market had declined almost 18% last night, making the losses over the most recent few days total more than 25%. Thus, a crash in Japan has occurred and may or may not have run its course. It is very difficult to tell what might happen next over there.
Cloudy Future for Land of the Rising Sun
The financial carnage in Japan precipitated about a 3% decline in the Spooz and various European markets, the metals, and many other commodities (i.e., everything was essentially in "liquidation mode"). When the U.S. market opened today, it was lower by a little less than 3%, then rallied into midday (prior to the FOMC meeting press release) to cut its losses by about one-third. It is still impossible to have any kind of a strong view about what is liable to happen in Japan and all of the near-term ramifications. However, one potential scary problem is, given the fact that interest rates have been so low there for so long, individuals and corporations (especially financials) have long been casting about the rest of the world in search of yield. Thus, as an unintended consequence of a decade of 0% interest rates there is a very large, structurally imbedded short position in the yen (something I mentioned recently). That is why, even with the Bank of Japan printing gazillions of yen, it continues to fly higher.
I can't begin to guess what might happen if the yen were to trade through the 80-per-dollar level, where there are rumored to be massive amounts of options and stop-loss orders. Nor do I know what sort of derivative structure may be in the Japanese banking system or insurance companies. But when one thinks about that, in addition to the shakiness of the sovereign debt of the PIIGS (and their banking system), it is quite clear to me that the world's financial infrastructure is potentially going to need some help from the authorities. In other words, more money printing is quite likely to be seen rather soon.
I bring up the potential for a Japanese-inspired derivative problem just for folks to be aware of and alert to clues that something may be starting to happen, although I haven't seen anything yet to suggest that is the case.
One of the few outcomes we can almost certainly predict at this point will be less use of nuclear energy (Germany closed seven of its seventeen reactors for three months today), as well as bigger demand for hydrocarbons at the margin.
The Shakeup Continues
As noted, last night's freefall in Japan led to all sorts of moves in commodity and currency markets, with the yen strong against virtually everything and the dollar tugged higher against most currencies in the process. Fixed income in the U.S. enjoyed a rally and Japanese government bonds did as well. I am keeping my eye on the JGB market just for signs that something different may be taking place, as it continues to act as though Japan was not struggling under the immense debt load of debt that it is.
Treasuries are enjoying the short squeeze I thought might have occurred were our stock market to drop, for any number of reasons, my favorite one being a "new" problem with the PIIGS. Nonetheless, Treasuries are probably embarking on a failed rally, and it will be important to keep our eyes on how that market performs.
As for equities, they are still in the midst of their decline, so it is too early to look for a big failing rally, but I suspect we will see that in stocks as well. Of course, the wild card in all of this will be money printing. My suspicion is that one of the reasons stocks in New York weren't lower early on was because folks were waiting for the FOMC to save the day. By the noon hour, folks were so giddy that high-flyers like Salesforce, F5, and Amazon were all flattish in the early afternoon, as they waited for presumably good news from Uncle Ben.
The FOMC statement was essentially a nonevent, but stocks continued to grind higher nonetheless, with cloud computing concepts and Netflix leading the charge. By day's end, the market had reduced its losses by over half. Ironically, the Nasdaq fared the worst, losing more than 1% even as its own high-flyers were the best individual performers.
Away from stocks, bonds gave up most of their gains as stocks recovered. Oil lost 3.5%. The dollar was mixed — lower versus the yen, but higher against most other major currencies. Silver lost 4% to gold's 2%.
Positions in stocks mentioned: none.
