It Started: Japan Just Broke The US Stock Market

Is America heading towards the recession? The Dow's down more than 1,000 points as that global selloff intensifies overnight. Japan's Nikkei plunged 12%; that is its worst day since 1987. Seems like a recession cannot be ruled out just yet.

What's up, you guys? It's Graham here. And apparently, we are... fluk. As soon as I go out of town to film for my podcast, the entire market goes into a complete freefall tailspin. Normally, I would just wait until I get home to make a video like this, but this is urgent and we need to bring you up to speed with exactly what's happening because this is not normal.

For the first time since 2020, we have the perfect storm of events all taking place at the exact same time, causing some of the largest single-day losses since COVID, and we all know how that turned out. So even though I'm rushing this out without many edits to try to get you the information as soon as possible, let's talk about exactly what's happening, why the stock market has fallen so much, what this means for you, and then what history tells us is most likely to happen next, since a lot of this is unprecedented.

Although, before we start, as usual, if you appreciate a makeshift studio like this and me filming really late at night to try to get you this information, all I ask in return is that you hit the like button or subscribe. That would mean the world to me. That's it. Thank you so much.

And all of this begins here: the Japanese Yen unwinding. Look, even though this sounds like a complicated term, it's really easy to understand if we break it down. On the surface, global economies are extremely interconnected. Like what happens in the UK has the potential to impact the United States. China's decisions have a large effect on the demand in the US.

And when one country is economically stronger than another, money tends to flow out and into something else, which is what's happening here. Even though our money has lost a significant amount of its purchasing power over the last 50 years, it's still the reserve currency in the world, and that means there's consistent demand for something like this. And no, I don't mean a $2 bill; I just keep this on me because it's good luck. Instead, I mean demand for US treasuries.

Think of it like this: every country has its own unique currency, interest rate, and inflation rate, which is constantly measured by what it gets you in US dollars. This means there can be arbitrage opportunities where you borrow in one currency at a low interest rate, put that in another currency at a higher interest rate, and then profit the difference; which is what's happening with Japan.

For more than 30 years, the Japanese Yen has been on a downtrend. In fact, their financial system is so bad, with decades of deflation, aging population, and weak demand, that interest rates remain at historic lows just to incentivize spending, borrowing, and trade. And they could get away with that because, until recently, inflation for them has been non-existent.

Now, in most cases, this isn't that big of a deal, and global interest rates tend to balance each other out. But recently, something changed because the United States battled with record high inflation from 2022 to 2023. They were forced to raise interest rates at the fastest pace ever in history. And all of a sudden, the United States was paying a very competitive interest rate that was completely risk-free.

This presented a very unique opportunity where traders could borrow the Yen at a low interest rate, put that in US dollars and treasuries at a high interest rate, and then profit the difference. On top of that, historically, the Yen has also gone down in value relative to US dollars, which means that by the time you actually have to pay off your loan, it'll require fewer US dollars to be able to pay it back.

So you could also make a profit on top of that by paying back less than you borrowed. As an example of this in really simple terms: imagine you borrowed 1.3 million yen at half percent interest, which would get you $10,000. You could then take that $10,000 and buy a 12-month treasury that earns 5.5%. If everything stays the exact same, after 12 months you now have $10,500, which is equivalent to 1,371,000 yen.

You pay back the 1.3 million plus interest, and now you have roughly $500 worth of profit, all while investing in something that's backed by the full faith of the US government. However, like I mentioned earlier, there is one factor that could either be the biggest blessing or curse when it comes to this, and that would be currency exchange.

In our previous example, investors got very accustomed to being able to borrow 1.3 million worth of yen and get $10,000. And 12 months later, when they cashed out, the Yen weakened, and all of a sudden, the $10,000 now gets you 1.5 million yen. This means that not only would you be able to make $500 worth of profit, but you also make an extra 200,000 yen for free because the US dollar went up in value relative to what you borrowed.

This of course seemed like a sure thing until it wasn't. That's right: Japan recently raised their interest rates in response to their currency consistently losing value, and as a result, this caused the yen to strengthen and the dollar to decline. Or put another way: imagine you borrow 1.6 million yen to buy $10,000. All of a sudden the yen increases while the dollar declines, and now when you have to pay back the loan, your $10,000 only gets you 1.4 million yen. So you're $200,000 short, and you have to come up with the money fast.

What do you do? Unfortunately, this is exactly what's just happened. As you could see on July 10th, one US dollar bought you 161 yen, and now, because of the rate hike, it only gives you 143 yen, a more than 10% decline from peak. And when you spread that across trillions of dollars invested throughout the United States in potentially leveraged positions, you have quite the storm. Essentially, all of this means that trillions of dollars had to be moved around or sold to pay off loans borrowed in another currency that now requires a lot more money to pay back than what was borrowed.

And boom, we have the makings for a stock market sell-off. In terms of how severe this is, Japan saw their single biggest day loss since Black Monday of 1987. Basically, just imagine if our stock market was down 13.3% in a day versus the 3%—well, that's what Japan just dealt with. Of course, some people might wonder: why would Japan raise interest rates like this if it's going to be such a big issue? The answer to that is inflation.

Remember, when the Japanese yen declines in value, it requires more of that currency to be able to buy goods and services from other countries. So they were forced to raise interest rates to prevent their currency from falling even further. All of this accumulated into a rather large, abrupt selloff. The thing causes a lot more fear, which causes an even bigger sell-off, which causes a lot more fear, and the cycle repeats itself.

Although the reality is this is just the tip of the iceberg, because on top of everything we have going on, we also have recession fears. Last week it was announced that US companies are no longer hiring at the same rate that was initially expected, with the chief economist of ZipRecruiter saying that the labor market's clearly no longer normalizing.

Further deterioration could set off a negative cycle of job losses, consumer spending declines, business revenue declines, and more job cuts. As a result of that, the unemployment rate increased to 4.3%, which some say is an indicator that the recession that we feared over the last two years is finally coming.

Why? Well, in this case, we have what's called the S indicator, which measures the unemployment rate relative to where it was a year ago. And since the 1950s, it's correctly predicted just about every recession that we've seen. In this case, if the unemployment rate's three-month moving average rises half a percentage point from its previous year, a recession is either imminent or already underway. You can see where I'm going with this.

Of course, do keep in mind that just like any indicator, there is a chance this could be a false positive. Like take a look at the inverted yield curve, which has been inverted for more than two years without a recession. So I'll really leave it to you to come to your own conclusions. But one thing is for sure: rising unemployment will or can be an issue. For example, oil recently fell to $73 a barrel on fears that people are going to be cutting back; demand is going to weaken and unemployment is going to increase because of that.

It's expected that exporters may begin to scale back production, and the impacts of that could last a very long time, which is precisely maybe why Warren Buffett is selling. No joke, I think he's out here playing chess while everyone else is playing checkers, because his timing is impeccable.

A few days ago, it was announced that Warren Buffett sold nearly half of his stake in Apple last quarter, raising $84 billion in the process. Not only did he seem to have timed the market perfectly compared to where we are today, but he also trimmed his position in Apple shortly before it was announced that Google violated antitrust laws by paying to have their search the default on Apple products, which made up 36% of their revenue.

All of this means that Warren Buffett raised a substantial amount of cash before anything like this occurred, essentially at the peak of the market. What a great move.

Although in terms of what this means for the future, here's where things get very interesting with rate cuts. As of now, some economists are calling for the Federal Reserve to make an emergency rate cut to help soften the blow. Others say the Federal Reserve is too late for rate cuts, since they should have started sooner.

As of today, the market is pricing in the strong likelihood of a 50 basis point rate cut as soon as this September. Now, if you think, "Oh great, the Federal Reserve is going to lower interest rates and then the stock market is going to go up," keep in mind that since 1990, every single time the Federal Reserve has lowered rates, the stock market has declined.

Why, I wonder? Well, historically, the Federal Reserve has not lowered interest rates unless they absolutely have to. It's not like they look at the stock market and say, "Ooh, the stock market's not going up as much as we want to; let's just give a little rate cut, and there we go."

Instead, they lower interest rates in anticipation of events that could be disastrous for the economy, and this has been the case the last three times—with the dot-com bubble, the Great Recession, and then shortly before COVID. In these cases, the stock market drop was not due to the rate cuts themselves, but rather the events that led to the rate cuts in the first place.

So, with all of this in mind, are we doomed? Not quite. As you could see, after enough time, there are plenty of occurrences where the market eventually begins to recover, some of which produce substantial returns, but you have to be patient. As of now, in the big picture, we're simply back to the same place the S&P 500 was three months ago—back in May.

That's it. We're down less than 10% from the peak, which is extremely common. For example, on average, a 10% market correction happens about every 16 months, and throughout the last 20 years, a 10% drop has happened 11 times. So, even though these circumstances are unique, stock market drops are not.

Does this mean the stock market can't fall even further? No, but it is too early to tell if this is just a short-term hiccup or if this is a signal that something much deeper is happening, and it could get a lot worse. I mean there's certainly a chance that the Federal Reserve lowers interest rates and that worsens the problem with the Yen, causing an even bigger sell-off than we saw now.

Or there's the chance that this is an absolute nothing burger; people panicked for really no reason, it was a short-term hiccup, and everything gets back to normal within a few days. That's why I think, either way, no matter what happens, it's always important to be prepared for the worst.

So here's what I recommend: I've said this many times before, but number one, always keep a 3 to 6-month emergency fund available at all times. This way, you're not going to have to sell off your stocks in the event of a reduction in income, you lose your job, or something happens where you have to sell at a loss. An emergency fund should be able to hold you through.

Second, it's really important to diversify your assets. Just like tech stocks lost about 78% during the dot-com bubble, if you're all-in on really volatile stocks or cryptocurrencies, there's a chance that you could lose a lot of money. At the end of the day, the more you diversify, the less volatility you're going to have, and the more insulated you're going to be in the event something happens.

And that's what I do: I try to be equally as diversified throughout cash, treasuries, index funds, real estate, and cryptocurrencies. So if something happens to one, I have something else to fall back on, and if they all go down, I still have some cash on the sidelines to be able to continue buying in.

Third, speaking of buying in, continue buying in. Look, I know how gut-wrenching it could be to watch your investments drop 10 to 20% in value. You think you're getting a great deal by buying back in, and then they drop another 10 or 20%, and it continues doing this until you're out of money. And then you panic sell, and then everything goes up in price.

I know it could be extremely discouraging. That is why study after study shows the best strategy out there is to continue buying and holding on a regular basis consistently. That's it!

Like even though a typical bear market might lose you 33%, a bull market on average sees a gain of 265% and lasts almost five times longer. So sure, losing money isn't exactly exciting, but with every loss comes the equal opportunity for a much bigger potential gain.

That brings us to number four: don't panic sell. I've noticed that the psychology that causes you to want to sell off your investments when everything goes down is the same psychology that causes you to want to buy back in at the peak because of FOMO. Resist it! Do not do it. Just stay the course.

As usual, on top of that, another aspect to consider is that over the last 20 years, a $10,000 investment in the S&P 500 would have grown to $64,000 if you just kept the money invested without touching it. However, if you missed the best 30 days over 20 years, your profits completely evaporate. As in, you make no money, which by the way typically happens after the worst days—assuming you could time that.

Step five: always keep a steady income. The biggest risk I see with a stock market drop like this is that, depending on the underlying conditions, it could be associated with a job loss or a reduction in income. That could affect your ability to either continue buying in or not sell if you need the money. Ultimately, you want to make sure you have a consistent income, so that you can keep buying in or you don't need to sell your investments should something happen.

And finally, six: if you're extra paranoid, keep some more cash on the sidelines. I know statistically this is not the best choice if you want to maximize returns, but for peace of mind, this is what it usually takes. I typically have a little extra cash on the sidelines because it helps me sleep at night. I know it's not optimal, but for peace of mind, I think it's worth it.

Oh, and then in honorary number seven, if you need the money in the short term over the next 3 to 5 years, it's probably not a good idea to invest in the stock market. That is because over the short term, it's not guaranteed that you're going to make money, and even over the next 10 years, there's nothing that says you can't lose money over that timeframe.

That's why I see this as a very long-term investment strategy, and if you aren't prepared to hold these investments for at least 10 to 20 years, I might recommend against it, or at least just know what you're getting into.

Ultimately, time is going to tell how this plays out. Typically, we see some of the best days after the worst, so I would not be surprised if over the next few days the market goes up quite a bit, and then maybe it goes down before it goes up quite a bit.

It's a roller coaster; it's a coin toss: heads or tails in terms of what happens. But let me know what you think down below in the comment section. I'll do my best to read as many as possible.

Thank you so much for being able to watch a video like this; I hope you appreciate it. As always, if you like videos like this, just make sure to hit the like button or subscribe. I've been up way too late; in fact, this is the second time I filmed this video because the first time the file got corrupted.

So if you appreciate all the work that I put in really late at night to try to get you this video, just hit the like button or subscribe! That's it! It would make it so worth it. Just hit the subscribe button, and it's free. Thank you so much, and until next time.