I’m getting a lot of questions right now about the overall market. People are noticing some strange trading. This morning, the S&P 500 ($SPY) and the NASDAQ ($QQQ) both opened down, traded back to flattish/up small, then fell in the afternoon ending the day down 1.6% and 1.4% respectively. The whole market is volatile right now – not just $AUID. Let’s dive in:

 

I believe what we’re seeing is related to the bond market. I started talking about the danger in the Japanese yen carry trade as early as October 2022. If you want to know more about that, just do a search for Japan on the DKI “Research” tab. I’ve spoken for hours and written more than a dozen blog posts and articles explaining the situation in Japan.

 

Earlier this week, Japan had horrible 30-year and 40-year bond auctions. The 30-year was at 2.88% a week ago and at 2.59% a month and a half ago. It closed today at 3.15%. That’s an enormous move in long-dated government bonds. The 40-year was at 2.58% in early April and closed today at 3.62%. Again, a huge move.

 

The concern about this is the people who own the multi-tens-of-trillion-dollar carry trade want to short the Japanese Government Bonds and buy US Treasuries. But with the yield spiking on the JGB, there’s less appetite to short these bonds or the yen. An unwind of the carry trade would result in massive selling of US Treasuries and an unknown amount of US equities.

 

On the US side, today’s 20-year Treasury auction was the reason for the afternoon market decline. That auction had a large tail which is a fancy finance way of saying there was less demand for those bonds than the current yield indicated. Falling demand means falling prices and falling bond prices mean higher yields. A month and a half ago, the 20-year yield was 4.42%. It closed today at 5.13%. The 30-year yield has risen from 4.39% to 5.09% in the same time period. Again, these are massive moves in long-dated government securities. Add extra emphasis for the fact that this just happened in the world’s reserve currency; the place investors go when they want to seek safety. These kinds of price declines don’t give investors much “safety” at all.

 

Some would think that these higher yields would bolster the dollar. (Higher yields make owning those bonds more attractive and you have to buy dollars so you can pay for the bonds.) Yet, the dollar price of gold was up today and Bitcoin traded at an all-time high of $109.7k. Dollar alternatives are strong indicating a weak dollar despite the huge increases in yields.

 

Everyone knows that our financial system is unsustainable. Japan has debt/GDP of over 250%. The US has $37T in on-balance sheet debt, $3T of on-balance sheet deficits, over $200T of off-balance sheet liabilities, and our annual deficits for on and off-balance sheet liabilities are around $7T or so. I’ve said for years that this will continue until the bond vigilantes make it stop. That’s when Treasury auctions have fewer buyers and yields spike. This increases the borrowing costs of the government at the same time that the amount borrowed goes up. Interest expense skyrockets and we print dollars to pay the difference. That leads to higher budget deficits, more inflation, and higher bond yields. Wash, rinse, and repeat.

 

Here’s the TL/DR version:  Due to too much government debt and unsustainably high budget deficits, the world is turning negative on fiat currencies. The risk-free safe-haven has become volatile and not safe.

 

Here’s what the government should do:  Congress needs to cut spending. Not at the margins like DOGE is doing although I’m supportive of those efforts. We need to cut trillions. For those of you who think we can solve this with higher taxes, the math there doesn’t work. We’d need to double tax collections to solve the on-balance sheet deficits and triple them to solve the on and off-balance sheet deficits. At the required tax rates, people would work less and the ultra-wealthy who pay most of our taxes would leave. Regardless of what you personally consider “fair”, it’s not going to happen.

 

In addition, Congress isn’t going to cut spending. We’re going to see a “big” fight for a few days or a few weeks where everyone in DC pretends to care about our unsustainable deficits, but they’ll be arguing about small spending changes at the margin. When the deal is done, we’ll still have multi-trillion-dollar annual deficits. I spent all of last year saying that we couldn’t vote our way out of our fiscal problems. The Democrats are openly socialists. The Republicans pretend to be fiscal conservatives…then vote for the same massive spending Democrats do. That means this isn’t going to change. Both parties want to overspend by trillions.

 

Here’s what we do:  Nothing. DKI subscribers already own huge positions in dollar alternatives and inflation hedges like Bitcoin and gold. We own high-growth individual equities that aren’t very economically sensitive. We’ve hedged out our market risk with market hedges. That plan was put in place for circumstances like these. Most or all of us outperformed the market indexes by a large margin today.

 

Here’s why I’m not making changes:  These government bond markets are manipulated. I read earlier this week that the Japanese government owns more than 50% of their own bonds. They could easily sell their foreign reserves of dollars and other fiat in order to buy more of their own bonds and bring yields back down.

 

The Federal Reserve could do the same. If markets break and we have a recession, Congress is likely to flood the economy with more stimulus funds (helicopter money). The Fed can easily add trillions to its balance sheet in a new round of QE. This would be unwise, but that’s what they’ve done before. That’s their playbook.

 

Right now, the US 10-year Treasury is at 4.60%. Traders are betting on whether that yield next crosses 4% on the way down or 5% on the way up. None of us know because a few people in government can determine the outcome. Without clarity, I think the right answer is to own growth equities, hedge market risk, and own dollar and inflation hedges. That’s what we have.

 

These issues are complicated. IR@DeepKnowledgeInvesting.com if you have any questions.

 

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