Transcription
Hello and welcome back to Braavos Research. This is your host Peter.
So, the semiconductor ETF SMH is leading the way on this rally, breaking out as of the making of this video, heading into the end of the week, solidifying the top spot for the semiconductor sector as the market leader today. We're going to dive in to a few of the setups that we currently have on semiconductor stocks right now.
Well, we're also going to take a look at utilities that seem to be lagging quite significantly on this most recent run, having printed a false breakout just last week. Meanwhile, transportation stocks, the transportation ETF IYT, is breaking out to new all-time highs. So, we're going to talk about all of these dynamics and what it actually means regarding the broad markets future outlook, short to medium-term, as well as where the opportunities are going to lie between these different sectors.
But before we get into all of that, I want to talk about Japan and the Japanese bond market that's making headlines this week over the last couple of weeks really, but more intensely this week as Japanese bond yields, especially on the longer end of the curve, are spiking here. This is the 10-year government bond yield in Japan and in late October it was at 1.7%. Now it's inching up towards 2%. What implications does that have for the US? Can there be spillovers into the US bond market? That's a big question that a lot of people are asking today. And also, what does it mean for Japan? What is this? What is happening? Why are bond yields spiking? I think these are very important questions to ask.
So, we're going to start with that because Japan is actually a very, very interesting case study when it comes to government debt and is very useful in order to understand the importance of government debt in the broader scheme of the macroeconomics, local and global macroeconomics. This is the government debt to GDP ratio for Japan and it currently stands at 236% meaning the total outstanding debt of the Japanese government is more than twice the size of the Japanese economy. Now obviously that's a problem. The government right any government takes in revenues tax revenues from the economy right whether that's people or businesses most of the time it's both. And that allows it to spend. Most of that spending is done through borrowing. When you have a debt to GDP ratio that is 236% the size of your economy, it means you have borrowed twice as much as your economy is actually able to produce, which puts you in a very vulnerable situation. One of the big big problems that you face in this kind of scenario is that the bond market all of a sudden doesn't trust your debt anymore, which makes interest rates spike, which is what's happening right now. By the way, we're going to talk about why it's happening now and why it didn't happen, let's say, in 2013 right here. But when your interest rates spike, it makes essentially your debt situation even more complicated because as interest rates spike, interest payments become more significant as in proportion to the rest of the budget. And that's when you get a debt crisis.
Now, what's very interesting about Japan is that their interest rate going back to the 1990s has been flat below 0.5%. This is the Japanese central bank interest rate and arguably they do not want to be raising interest rates in any kind of real way because of their debt load. Right? If they begin to raise interest rates and we saw that for example with the US government in 2022 2023 as the Fed raised their interest rate quite aggressively it caused government interest payments to spike. Interest payments became a much more consequential part of the total government budget. And so that's squeezing the government's spending. It hasn't brought about a debt crisis because we haven't had the negative feedback loop where enough people are actually selling US debt to cause a major major move up in interest rates which is what you saw for example in Greece. But you are seeing to some extent an impact of the interest rate hikes from the Fed on the government's budget. It's why Donald Trump is very much pressuring the Fed to lower interest rates. why he's going to be choosing a Fed chair that's a lot more susceptible to lowering interest rates, not just to stimulate economic growth, that's part of it, but also to relieve the government of its fiscal pressure. So, the Japanese central bank is in a situation where they can't really raise rates much much more without really having an impact on the government's budget and really causing problems in regards to interest payments in Japan.
Now the problem is that the Japanese central bank doesn't control all interest rates, right? And what you're seeing now is the longer end of the curve in Japan as we just looked at is beginning to rise quite aggressively. And although it was roughly trending down and generally at the zero bound between 2013 and 2022, let's say, since then we've really had a complete 180 of Japanese long-term interest rates. So on its own, this is really a representation of a loss of confidence in Japanese debt, which is absolutely normal given that the Japanese government has been quite reckless in their spending over the last 2030 years, a debt to GDP size of 200% should not be sustainable. And so for a reason that I'm going to share in just a second, primarily inflation, the market is finally waking up to the fact that Japanese debt is not that attractive of an asset, that it's even a risky asset to hold. And what happens when debt becomes risky? Well, you see interest rates spike. And so that's what's happening. Investors, the market is seeing Japanese debt as being increasingly risky right now.
Now, we're going to talk about how much runway there is for this to actually turn into a full-blown crisis, but the reality is this is quite a tough situation for the Japanese government. As I mentioned earlier, if interest rates continue to spike, it's going to squeeze the government's budget. And so, they're going to do what they can in order to suppress the bond market, in order to suppress bond yields. What they can do that, right? They can buy Japanese bonds. They can do quantitative easing, something that they actually did quite extensively during this period. And that can be an effort in order to actually bring interest rates back down. The problem is that artificially suppressing interest rates depending on where inflation is can be super super inflationary, right? It can push people to spend. It can push people to increase their inflation expectations to borrow money. So, if you're printing money in order to buy bonds to artificially suppress your interest rates, which is something that they're probably going to be forced to do in order to avoid some kind of a default or a much larger squeeze of interest rates where Japanese bond yields go up to 10, 15%, like maybe even higher like what happened with the Greek debt crisis in 2011. Greece that does not have its own central bank that is reliant on what the ECB does, right? They was not able to actually print money to suppress their interest rates. Japan on the other hand can absolutely do that and it's probably what they're going to try and do. And so that could perhaps build a very interesting setup in regards to the Japanese yen because when the market firstly let me add the Japanese inflation rate on top and you can see that one of the characteristics of what's happening today is that we've had sustained inflation above 2%. So not crazy amount of inflation for now in Japan but definitely higher than the average of what they've had over the last 40 years. They had a couple of brief spikes in inflation, but what we're seeing now is a lot more sustained, right? They've had higher than average inflation since May of 2022. And that's when these Japanese bond yields began to curl up. And we haven't really seen what typically happens is a crush down of inflation in Japan, which brings back the interest rates towards the zero bound. And so the longer inflation stays at this level, the more room there is for these bond yields to continue rising. Currently, they're at 1.8%. Inflation, and let me put this on the same scale. You see what I'm talking about? Inflation is still at 3%. Right? Inflation is still at 3%. So in Japan, you still have very much negative real interest rates, meaning interest rates are below the rate of inflation. That's not the case in the US. Interest rates are above the rate of inflation in the US. What we know from economics is that negative real interest rates is inflationary. Right? As I mentioned earlier, this makes people borrow money. It makes people not want to hold the Japanese yen when you're losing purchasing power year after year by holding the Japanese yen. Well, that's going to make you want to sell the Japanese yen or spend the Japanese yen and that can create inflation right now. Again, you had negative real interest rates briefly in 2013. Absolutely. But it was temporary, right? And so just like the market thought it would be temporary in 2022, 2023, interest rates were still overall quite flat in Japan, this time it's not proving to be temporary. It's proving to be more sustained inflation. And so this is giving the bond market enough time to actually react to these negative real rates and make yields spike back up.
So you're going to see Japan in a very very tough situation here where either they're going to let interest rates reach the levels where they should be at which could be 3% but it could be higher than 3%. We know that when a government has debt to GDP levels that are above 100%. We know that that has an impact on the trust of that debt which makes interest rates rise. And so at a 236% debt to GDP ratio, you would expect that Japan should actually have higher interest rates than the rest of the world. So if you assume that inflation stays around 3%, you could guess that Japanese interest rates could spike to 5%. The problem is again that would have disastrous consequences on the Japanese government's budget. So the second option is that they don't let interest rates spike, that they begin to buy bonds, print money in order to suppress their interest rates. But again, that's going to widen the gap or at least keep the gap very wide between inflation and interest rates. So, I know this sounds quite complicated, but ultimately, if they do this, real rates are going to stay negative or even go even more negative, and that could be inflationary. So, that could stimulate inflation. And while the bond market could be stable in that type of scenario, the Japanese yen would lose a lot of confidence.
So, let's take a look at the Japanese yen here. This is the US dollar against the Japanese yen. So when this line rises, it means the Japanese yen is weakening, right? This is chart that goes back to the 1970s. And so one of the things that we've seen since 2012 is generally a weakening Japanese yen. Right? That's been the theme for the last decade now. As a result of these concerns around government debt and more recently as a result of these concerns around negative real interest rates, that makes the Japanese yen a less attractive currency to hold. So that's the typical sign of an unfolding debt crisis is that you see the interest rates spike at the same time as the currency is weakening, right? So that's a big warning, right? Because it tells you that the spike in interest rates is not enough to really make the currency more attractive to investors. So again, cut a long story short, but if we add the Japanese inflation rate on top of this, you can see it really does come down to what inflation does. The Japanese yen is very correlated to what inflation does because the market knows this story very well. If we see Japanese inflation get crushed, we're probably going to see some strength on the Japanese yen again as it's going to reassure Japanese debt holders that they can actually hold on to their debt because yes, Japanese inflation is structurally low and so you're not going to get the purchasing power of your asset get completely crushed. On the flip side, if inflation stays at elevated levels and you see some kind of an action by the Japanese central bank to try and suppress interest rates, which would be inflationary, that's going to weaken the confidence in the yen and it could potentially weaken it quite substantially because nobody wants to hold a currency that's yielding negative real rates and has a debt to GDP ratio above 200%. So although we've had already quite a lot of weakening in the yen, we're definitely given what's happening in the bond market, given what's the resiliency of Japanese inflation, it's very very surprising. I really would not be surprised to begin seeing the Japanese yen take out this very very long-term level at 160. That, by the way, would be a structural breakout of a 40year basing pattern and potentially set off a very very large decline in the Japanese yen because this would quickly turn into a currency crisis where the weakening the local currency actually creates inflation which further weakens the confidence in the currency. So, this is something to watch out for. I think the 160 level is something to definitely watch out for even a currency trade. I'm not sure that the Japanese stock market would do particularly well in that type of environment. Right? Typically, you actually see Japanese stocks decline during these types of very strong moves on the US dollar against the Japanese yen. So, when the Japanese yen is weakening, you tend to see Japanese stocks actually decline. We saw that in the 1990s. We saw that here again. We actually saw this again here in 2021 right there. But it could, as I mentioned, a very interesting macro currency trade shorting the Japanese yen on this in anticipation of a large breakout above 160. This could already be used as that. And if we get that breakout, we could be even adding to that position and making this one of our core bets on the Japanese yen. So, we'll take a look at how easy it is for individual investors to actually participate in that. We don't want to be initiating trades that most of you guys are not able to participate in. But yes, perhaps you can leave a comment down below if this is a trade that you would be able to actually participate in. This is by the way a little bit longer term as well. But once these types of themes actually get going, it can cover a lot of ground very quickly, right? The Japanese yen moved very very aggressively in 2022 when the breakout actually occurred. And you can see that breakout occurred roughly around this zone, right? 114. Once it really broke that level, it just took off. And you can of course in the forex markets you can use leverage because the size of the moves are a little bit less interesting.
Now the other impact that this would potentially have on in terms of spillover to the US. There's two ways it can spill over. It can spill over to the bond market. We're going to take a look at that. Although I think the effects of that will be generally quite muted I would suspect. But there's also the angle of the carry trade. And for those of you who don't know, the carry trade is simply investors borrowing in Japanese yen to invest in US based assets or US tech. And the carry trade has been building up for the last decade as Japanese interest rates have indeed been very low, allowing institutional investors to borrow money in order to leverage themselves up in a cheap way and to go long on the assets with the most momentum like US tech. And so indeed, one of the things that was quite concerning to a lot of people back in 2024, and I believe this was in July of 2024, you can see we had a very, very large drop in the US dollar against the Japanese yen. So a very large appreciation in the Japanese yen right here as it bounced off of that 160 level, right? And the big concern was that this was going to have a huge negative impact on attack. And it did. During that sell-off, it did cause a little bit. It's hard to say exactly how much of that was as a result of the Japanese yen, but certainly it seems like there was a big correlation between US tech and the Japanese yen at the time that had melted up right here and then collapsed at the same time. So, if we're going to see a Japanese yen that continues to weaken looking forward, especially if that's accompanied with the Japanese central bank beginning to buy Japanese bonds in order to suppress interest rates to avoid some kind of a debt crisis, that could make the carry trade resume and actually make it a lot worse, right? and fuel the kind of riskon behavior that we've been talking about for a while now with a lot of parts of the market getting increasingly euphoric, increasingly frothy, but with a macro environment that's generally favorable to that continuing, well, the Japanese carry trade has been indeed one of those aspects contributing to the extra momentum that we've seen on US tech and would certainly continue to if it were to continue weakening. So that would be the first potential spillover that I think is definitely within the cards to actually see this correlation between the NASDAQ 100 and the Japanese yen that we really started to see here in 2023. It seems that really have a kind of very correlated relationship between US tech, the NASDAQ 100 and the Japanese yen. And so as the Japanese yen here is breaking out, it's a signal that potentially we're going to see a resumption of that.
The other potential spillover, and I think this is perhaps where we diverge away from some of the news headlines that are going around recently is the potential spillover on the US debt market. And the argument is of course that as Japanese interest rates are becoming more attractive that that's going to push Japanese debt investors to move away from US debt and into Japanese debt. And that would be worrying because Japanese investors are big holders or significant holders of US debt. And so you could make the case that these two markets are very interconnected and that Japanese bond yields do have an impact on US interest rates. But there are a couple of arguments against that. The first one is if we merge these two scales here, you can see that there is ways to go here. Ways to go before Japanese bond yields come anywhere close to where US bond yields are. Right? And by the way, US inflation is also at 3%. Right? Same inflationary data as Japan. And yet interest rates in the US are above the inflation rate at 4%. In Japan they're 2%. So on an inflationadjusted basis and US bond yields are more attractive than Japanese bond yields and when you take into account the levels of government debt the situation is also less interesting in Japan with as we mentioned over 200% debt to GDP ratio. So no, if I was a Japanese investor, you know, just looking at this from bird's eye view, it doesn't seem like Japanese investors are going to be rushing out of US debt to get into Japanese debt because Japanese debt has so much risk right now that really you don't want to be touching Japanese debt unless you think that Japanese inflation is going to get crushed and you're going to see deflation in Japan again. That's the only reason where I would be saying, okay, Japanese bond deals can actually come down in a meaningful way and be an interesting hold for Japanese bond investors, not just the Japanese central bank that would be buying bonds. So, no, I generally don't think that there's going to be any impact on the US bond market from Japan. There could be a little bit of an impact on the dollar, however. If there's a big depreciation in the Japanese yen, it's going to be reflected in a higher US dollar index. We can take a look at Japan against the Japanese yen, right? US dollar, Japanese yen against the US dollar index and they are very correlated. But again, relationships can change and right now we're seeing what looks like a divergence between the two. This could, by the way, from a portfolio allocation standpoint be quite interesting in terms of diversification to short the Japanese yen because we're quite exposed to US dollar weakening asset, right? We have industrial metal, we have copper, industrial metal miners, we have silver, we might add other weak dollar assets. A bet against the Japanese yen would be a way for us to hedge against that. Because if we're completely wrong about the dollar weakening from here and we see a big rally on the dollar index, that would be accompanied by that big breakout that would almost guarantee a big breakout on the US dollar to Japanese yen chart that we talked about above that 160 level. So having exposure to a short trade on the Japanese yen would be a way of hedging against any kind of dollar appreciation while still being a bet that could very much do well even if the dollar weakens because of the idiosyncratic risks that are taking place right now in Japan and in regards to Japanese debt. So I think this is a very interesting theme and I wanted to highlight this. It's a little bit different to what we usually do, but let us know in the comments if this is the type of research that you guys are also interested in on top of US markets.
Now, we're going to come back to taking a look at what's going on in US tech today. Because firstly, let's take a look at the S&P 500. Very, very nice price action. Markets remain strong, inching towards all-time highs and breaking through that resistance as we had talked about. But it's interesting to see a little bit of the shift in the leadership that we're seeing here. We had already talked about IWM, the small cap index that has been one of the strongest parts of the market on this rally, which is very constructive, right? And one of the reasons why we're really have a bullish bias right now is this very strong price action on the Russell 2000. I wanted to show you this pattern here that has broken out on IWM. Very, very strong behavior right below alltime highs. It seems like we're going to see a break to new highs on the Russell 2000. We're also seeing very strong behavior on tech. Let's take a look at the tech sector against the S&P 500. It was looking a little bit better this morning. It was attempting to break out very nicely here. Seems like we're getting a little bit of a bottoming type of price action. There's more work to be done, but it is looking more and more like a resumption of just the uptrend that we've been in. And so far there's no real evidence for us to say, "Hey, this is not a bottom." In fact, one of the things that is kind of pointing us in that direction as well is that some of our most successful trades in the last few weeks have been on TAC. And you can take a look at Applied Materials that we initiated right here on the breakout that has been relentless making a new all-time high here, hitting our target, just booked profits on this stock. But look at the strength, right? There's very very few stocks that have been able to be as strong as this in the S&P 500. And it seems that the ones that are being this strong right now are happen to be int.
Now, it's not across the entire tax sector. It's interesting. We're seeing a little bit of a different style of leadership. And this is something that we've talked about before that it's not always going to be the same leaders, right? There's going to be some rotation. For example, Nvidia's still under pressure right now, right? So, not necessarily something we want to touch here. I think a lot of people, a lot of retail bought the dip here and is hoping for Nvidia to kind of continue its meltup based on its very strong earnings forward guidance and perhaps it does. But the weakness, the relative weakness that we're seeing even against other parts of tech is quite concerning here and relative to GEV for example, that's not a semiconductor company, but it is very tied to tech. You can see very very nice breakout here, breakout here. As we had discussed a couple days ago, it seems GEV is sticking that breakout at least for now. Very strong posture. KAC, a semiconductor company here that has also been able to break nicely back into a bullish structure here. TSM also trade that we initiated yesterday that was able to break above this trend line and also emerge out of this very nice bottoming pattern right below resistance. Now we did ramp up our tech exposure a little bit. So we have those trades that I just mentioned although we did trim applied materials a little bit. We are more heavy on tech than we were a couple weeks ago. Now our thought process regarding that is well the market rally is continuing right and it seems that tech is one of the leaders in this rally right it's been the case during this entire bull market that tech has been leading and we have so far not enough evidence for us to say hey this is not going to be the case anymore in fact quite the opposite when you look at the relationship of the tech sector against the S&P 500 and you compare that to the actual performance of the S&P 500 00, right? You see that when the S&P 500 is going down, tech is underperforming. When the S&P 500 is going up, tech is outperforming. And this recent correction here started in late October has just been about tech underperforming, big rotation out of tech. And this recovery has so far been accompanied with a tech leadership. Right? So essentially what I'm trying to say is nothing has changed in the behavior of the market leaders apart from some individual names within the tech sector that are a little bit rotating here and there and that we have to stay open-minded to other leaders, other stocks leading the way than what has been the case perhaps since the April low. For example, Microsoft that was one of the big big leaders in the initial part of the rally has been a huge disappointment since really late July. Big double top on Microsoft and has since not been able to recover. It could change. It could be that it recovers again, but for now we don't have enough evidence of that actually happening. Meta still not a great look right now. Although it has had a little bit of a recovery here. Overall, a little bit too weak of a structure for us to get excited about. Amazon, same thing, right? Big false breakout here. And now we're just trading at resistance. Not great price action. We really want to see it come back above that zone of resistance. Perhaps will start to get more excited about Amazon in the 24243 range because yes, this is an interesting fundamental setup as we've talked about Amazon many times.
Bitcoin, not a stock, but also worth looking. of course, one of the big leaders of momentum stocks in general heading into the end of July of 2025. All of a sudden became the weakest part of financial markets more recently. So also something that we really want to see an improvement in the structure before we get more serious about Bitcoin or crypto in general. As you can see, this is the crypto total market cap excluding Bitcoin and Ethereum that is still at resistance and seems to be, as we're making this video, rejecting off of that resistance, which is not the greatest sign to see in regards to short-term price action on these cryptos.
On the flip side, what we're seeing is yes, again, tech continuing or at least parts of the tech sector continuing to actually do very well. IWM as I mentioned earlier doing very well and also the transportation sector that is also doing quite well. Now, it has still work to do and it's not made a structural breakout of this pattern that you see here, but it is breaking out very nicely above a shorter term basing that started in November of 2024, right? That we know is marks a kind of rolling recession type of behavior where we had a lot of growth concerns in this period. The Fed responded, the Fed has been cutting interest rates throughout that period. Now, we're seeing what looks like a recovery from this general period of weak real growth over the last couple of years. It could be that transportation stock are once again ready to kind of break out in a much more real way if we're seeing a true economic recovery happen, which could be the case. But again, I think a little bit more room in order for us to get convinced of this. You can see on a relative basis against the S&P 500. This is IYT, so the transportation ETF against the S&P 500. We have an attempt at a breakout today. We're going to see if that sticks, but that could be interesting for potentially a more sizable move of outperformance against the S&P 500, which would mean that essentially transportation stocks lead the way up as the S&P 500 continues to move higher because I really would not expect that if this is happening, right, if we're seeing a cyclical pickup, right, because that's what transportation stocks are. They're cyclical stocks. If we're seeing a cyclical pickup in momentum, I would be very very doubtful that that is accompanied by any type of weakness on the S&P. And we can see that by simply overlaying the S&P 500 against this chart. And you can see that most of the time, it's not all the time, but most of the time when transportation stocks do well, the S&P 500 is doing well. Right? I'm just highlighting a lot of those moments right here. But a lot of the big big moves up in transportation stocks were accompanied by moves up in the S&P 500. We had just one exception in 2008 right here where transportation stocks were actually more resilient during the early parts of the great financial crisis. And you can see IYT here actually made a new high in May of 2008 right here. despite the S&P 500 index actually rolling over quite a bit. So quite peculiar type of behavior on the transportation sector heading into the 2008 financial crisis. But the other examples here 2004 2006 right here all of these were accompanied by generally strong moves up on the S&P 500. So if we can add this to our kind of toolbox in terms of breadth right we love to look at breadth market internals and understand if a rally is actually being supported by various important and cyclical sectors and that a lot of stocks are participating all of these are green flags for us. Well, this most recent move on the transportation sector is definitely putting a little bit of extra weight to that argument that we've been making that breadth has been strong on this most recent run.
Of course, this can all change quite quickly. this is the direction that we've generally been leaning towards over the last few weeks. But that's not to say that there's not still tail risks in the market right now and that if you see yet another whipssaw here, yet another false breakout on the main index that is accompanied by big big declines on the small cap index, the homebuilders that the transportation stocks retrace their entire move that that wouldn't put us back in a much more cautious stance very quickly. we really would want to see this structure and this support level hold. If this does not hold, that starts to look a little bit more worrying. Not necessarily open the door for a very very large move down, but definitely does speak to indecision regarding the market and that we would be a lot more in a kind of choppy market environment rather than a full-blown recovery look following this correction.
So hopefully you guys enjoyed this update. If you have any comments, questions, feedback, make sure to leave them in the comment section down below. It is very much appreciated. I wish you all a very good weekend. In the meantime, I wish you good luck on your trading and see you next.