Bad News For The Nasdaq

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The Nasdaq has been underperforming recently.The US dollar/Japanese yen carry trade unwind has impacted QQQM, and it is unlikely to be over.Japan's new PM, Shigeru Ishiba, supports further rate hikes,...

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Kutay Tanir The Nasdaq (QQQ) has been unusually weak in recent months. After leading stock markets higher for most of the last year, it is now lagging and stuck at lower highs while the S&P500 (SPY) is making new all-time highs. This article looks at why this has happened and some news that could exacerbate the situation.  A Quick Look at QQQM Most readers will already be familiar with the Invesco QQQ Trust ETF (QQQ). I use the nearly identical Invesco NASDAQ 100 ETF (NASDAQ:QQQM) as it has a slightly lower expense fee of 0.15% compared to QQQ's 0.2%. There are two aspects to QQQM which help explain why it is lagging. Firstly, its PE ratio of 31.5. This didn't seem to matter in previous quarters but Q3 brought a growth scare and a spike in unemployment which suggests that the economy will be weaker than previously assumed.  Secondly, its holdings -  QQQM Holdings (Seeking Alpha) The \"Mag 7\" stocks make up most of its top 10 and constitute 42.7% of its AUM. This has been a major driver of outperformance in previous quarters, but in Q3 the stocks weighed.  Data by YCharts Why they started to weigh will be explained in the next section.  It's Crowded in Here The “long Magnificent 7” trade is the most crowded, the BofA Securities Global Fund Manager Survey for July said. According to the survey, 71% of investors think \"Long Magnificent 7\"...is the most crowded trade. This is the biggest crowding survey answer since “Long U.S. Tech” in October 2020.  Most of us knew that anyway, but it hadn't made much difference to performance until July. To prove this point, July was the 16th consecutive month that “Long Magnificent 7” had been the most crowded trade. The second most crowded trade, with 12% of the vote, was Short Japanese yen (YCS). Initially, this looked unrelated to Mag 7, but we found out in late July and early August the two were closely linked. The Carry Trade  There are two elements to the US dollar / Japanese yen carry trade. The classic trade is to sell the yen and buy dollars and take advantage of the interest rate differential. Forex trades often use huge leverage to make this trade attractive.  The second is to borrow yen at low-interest rates in Japan, convert them to dollars and buy US assets. Mag 7 stocks were very likely the target for this trade. This situation continued without problems for several years, but a major shift happened in July to unbalance it. The Bank of Japan hiked rates just as the US experienced a growth scare. So while Japanese yields rose, yields in the US dropped. Most importantly, USDJPY fell nearly -13% in just 18 sessions. The USDJPY drop caused a mass unwind of carry trade positions and led to margin calls on leveraged bets. Mag 7 stocks were particularly affected as not only were the yen funded trades closed, crowded trades were a source of funding to cover margin calls. Crowded trades like Bitcoin and the Nikkei also fell. The chart below shows QQQ and the Nikkei have been closely linked since July. It also shows the Nikkei made another sharp fall in recent sessions, and this could be more bad news for the Nasdaq.  QQQ v Nikkei (Tradingview) It Will Take Time to Unwind The worrying thing about the carry trade is that it is multi-faceted and no-one quite knows how large it is. That was one of the reasons for panic on August 5th. The currency side is the largest aspect, but borrowing in yen has also ballooned. Data from the Bank for International Settlements (BIS) suggests cross-border yen borrowing has increased by $742bn since the end of 2021.  Non-bank financials make up a large part of the borrower type.  ING This isn't the kind of positioning that can unwind quickly or without affecting related markets.  The Next Leg? The Nikkei dropped -5% sharply on Friday as Shigeru Ishiba was made leader of the ruling Liberal Democrat party and therefore the new Prime Minister. This is bad news for the carry trade, as Ishiba is seen as a hawk and has been very critical of the BoJ's ultra-loose monetary policy. He supports further rate hikes and will enable Governor Ueda, who has been warning markets repeatedly that more hikes are on the way if data continues as expected.  USDJPY had been making a tentative recovery off fresh 2024 lows but also dropped over -3%. Other markets were not affected significantly, but QQQ did close lower on Friday for the second session in a row and faded after a positive week. The moves in USDJPY and Nikkei may just be a knee-jerk reaction. There was some hope for the dovish leaning Takaichi to be made leader, so there was an element of this expectation being priced out. The risk is, however, it is merely the start of a fresh carry trade unwind and the next leg lower in USDJPY, the Nikkei and QQQM. Takaichi may have been the last hurdle to further hikes, and the path is now clear for Ueda to tighten further. Traders may wait until he does so, but it would be more sensible to unwind now while the markets are relatively steady. Indeed, you could argue the carry trade has gently been unwinding in the background all through August and September and is why QQQM remains at lower highs.  QQQM Outlook October could be a difficult month for QQQM, with election uncertainty likely to add to the carry trade negativity. However, once earnings season gets underway and the election is resolved, the outlook looks better as this has been a bullish year in general and bullish years tend to end strongly. Indeed, the weak period in Q3 may be positive, as it helped reset positioning and compressed the PE ratio slightly. I will be a buyer of QQQM weakness later in the month.  Conclusions  The unwind of the carry trade has weighed on the Nasdaq in Q3. News that Ishiba will be Japan's new PM could exacerbate the situation, as he is a clear hawk that supports further rate hikes. Q4 may get off to a weak start, but a dip could set up a rally into year-end, and I rate QQQM a \"hold\" or a \"buy\" if it drops near the September low.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2472400300"}