Japanese stocks rebound after global sell-off; US futures edge up

Matt Levine wrote a bit about market crashes on Monday, putting this into perspective:

Market crashes usually have the same mechanism. People like a thing, so they buy it, so it goes up. More people like it, so they buy more of it, so it goes up more. It goes up steadily enough that people think “ehh I should borrow some money to buy even more of this thing,” so they do. Eventually a lot of very leveraged investors own a lot of the thing. Then something goes wrong with the thing, its price goes down, the leveraged investors get margin calls, and they have to sell the thing to pay back their loans. Their losses are big enough that they have to sell other things, things that were fine, to pay back their loans on the thing that went wrong. The big leveraged investors who owned a lot of the thing that went wrong also all own the same other things, also with leverage, so there is a generalized crash in the prices of the things that big leveraged investors own.

In the special case in which the big leveraged investors are banks, this sometimes leads to a contraction in credit and serious economic consequences. In the general case in which the big leveraged investors are hedge funds, it’s mostly fine.

In this case, a particular kind of leverage is the “carry trade.” An example of that is investors who borrowed a lot of money at low interest rates in Japan and then invested it somewhere else like the US. This exposes them to currency risk. When the Yen goes up (and it just did, from a five-year low in early July) and the news is bad, they panic.

I find this somewhat comforting in that it’s pretty technical explanation and doesn’t necessarily mean that the world is fundamentally messed up more than usual. People look for big-picture reasons for a crash and point to well-known, obvious ways that the world is messed up, but that might not be it?

On the other hand, volatility due to technical reasons might shake something else loose? Aren’t there fragile markets held up by nothing more than optimism and perception? They might not recover.

I’m not sure what would count as such a thing, though? I sort of think of Bitcoin as held up by nothing more than optimism and perception, but it has widespread fame and really persistent optimism that survived downturns before. I hope it fails for environmental reasons, but that’s the power of a brand. Some other cryptocoin you never heard of might never come back, though.

Another thing Levine points out is that the places where hedge funds make levered bets usually have some more fundamental demand behind them:

And so you get crowding: The big hedge funds do pretty overlapping trades, because those are the trades for which there is demand; those are the business units that have some economic niche. “Australia wants to borrow money, Japan wants to lend money, so we will borrow yen and lend Aussie” is a very straightforward economic story, a real business function that hedge funds do via the carry trade. (“Let’s all buy Nvidia” is a slightly different story, but there again there is probably some reason for crowding.) So they do a lot of it (and not so much the reverse), and so all the big trades tend to unwind at once.

The stock market is really scary right now, heavily debating pulling out everything while I still have some profit and just parking in a HYSA while I build up my house downpayment

Mirror: https://archive.is/BMQw2