OTW #40: Almost ready to buy JNK, Dollar damage, Free strategy videos, and more
Important financial stories to check out over the weekend
Hi Antagonist readers,
It’s time for another edition of “Over the Weekend.”
1. Dollar damage: the U.S. dollar feedback loop.
The average investor is unaware of—or at least underestimates—the impact that the U.S. dollar has on global markets. That impact, however, cannot be overstated. Fluctuations in the dollar send shockwaves all over the world.
Luke Gromen, one of the most respected names in financial research, provided a superb explanation on Macro Voices. Here’s a summary of what he calls “the dollar feedback loop”:
It’s a paradox that most people seem to think that the dollar rising is a sign of the U.S. winning. It’s not. It’s a sign of the U.S. dollar system unwinding itself.
[E]very tick higher in the dollar forces foreigners to sell more treasuries. They own $7.5 trillion in treasuries, $3.8 trillion at the central bank level, most of which is longer duration treasuries. So as the dollar rises, their cost of offshore servicing, offshore dollar debt rises, they need to sell something to defend their currency to raise dollars to serve U.S. dollar debt.
And so, what do they sell?
They sell what they can, not necessarily what they want to. They sell treasuries…
[E]very tick higher in the dollar increases treasury supplies, then as the dollar goes higher, and as foreigners sell more treasuries, that sends rates up, which then feeds back into the dollar, which then feeds back into treasury sales, which sends rates up, which then feeds back into the dollar, which sends rates up. And so we are living that feedback loop right now.
And then where it starts to get really nasty—if that’s not nasty enough already—is, U.S. banks own $4.1 trillion in U.S. Treasuries and agency mortgages. They’ve sold down from, call it $4.6 trillion to $4.1 trillion, over the last 18 months as rates go up, they start to have credit losses…
But they need to sell something because commercial real estate is getting worse, as rates go up. Credit cards get worse, as rates go up, car loans get worse as rates go up, etc., etc.
So now every tick higher in the dollar drives every tick higher in yields, which drives the banks to join in the nonlinear, very convex increase in the net effect of supply of treasuries. And so you can see how this dollar feedback loop will continue.
Now, the reason why this is bad for the U.S. is that ultimately, we’re a financialized economy. And you’re talking about taking down the treasury market. You’re talking about taking down the banks.
I cannot emphasize enough how much the value of the U.S. dollar and the treasury market impacts stocks and the overall economy. If these concepts are new to you, or if you just want more data about what’s driving global markets, listen to Gromen’s interview on Macro Voices. After just 35 minutes, you’ll understand the financial system more than the overwhelming majority of individual investors.
You can also track the value of the U.S. dollar by monitoring the DXY index.
2. Credit spreads still climbing.
In last week’s Over the Weekend, I showed how high-yield credit spreads have started to creep up. That uptrend continued this week with the spread widening another 8.7% from (4.03 to 4.38).
I expect spreads to continue to climb from here and even hit a blow-out top like you see at different points in the chart above.
When that happens, I’ll buy the SPDR Bloomberg High Yield Bond ETF (JNK). That’s because bond prices and yields are inversely related. So, when JNK’s yield pops, its price will crash. That’ll be the moment to pounce.
Eventually, spreads will start to shrink back to normal range. That’ll be the time to sell. It’s the classic buy low, sell high strategy.
To learn more about why this works so well with credit spreads and high-yield/junk bonds, check out the article I wrote earlier this year.
3. “Active” ETFs are gaining traction.
Most individual investors buy passively-managed ETFs. These ETFs simply track the performance of an underlying index like the S&P 500 (SPY) or the Nasdaq-100 (QQQ). The managers of those funds aren’t trying to pick and weight individual stocks. That work is already done for them by the index composition itself.
With interest rates rising along with the risk of a market crash, however, actively-managed funds are rapidly growing in popularity.
This summary from Oktay Kavrak explains why this shift is occurring:
The biggest active ETF in the world (JEPI by J.P. Morgan) now has $29 billion in assets under management.
Last year, it broke Ark Innovation ETF's 2020 record for net inflows by an active ETF (bringing in $13 billion).
And this year it’s on pace to break that record: already attracting $12.3 billion in new money.
So on the back of JEPI’s success, J.P. Morgan just unveiled the “Hedged Equity Laddered Overlay ETF.”
Ticker: HELO 👋
It’ll track dividend-paying stocks in addition to selling S&P 500 call options to generate additional payout streams.
Essentially, the aim is to dampen some of the S&P 500’s losses at the expense of potential gains.
These income generating ETFs are getting unparalleled attention this year.
Investors are worried about rising yields and tech-driven market gains.
These ETFs offer respite by providing ‘yield’ in case the AI hype dies down and markets hit a choppy stage.
For example: JEPI dropped -3.5% on a total return basis in 2022 (compared to the -18% plunge for the S&P 500).
WSJ recently reported that active funds have drawn 23.3% (!) of total ETF inflows this year - despite making up just 4% of assets in January 2023.
But the rest of the industry is taking note.
BlackRock just entered the race with copycat ETF "BALI" 🌴
It tracks dividend paying companies (*unlike JEPI, which isn't solely dividend-focused) and offers investors exposure to income from call options on the S&P 500.
Oh and Goldman Sachs recently announced plans to launch two option writing fixed-income strategies back in June.
Imitation = Sincerest form of flattery.
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Thank you for reading, and have a great weekend!
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