The Dow is going to close below 13000 for the first time since August 16th. Why this is an important date? For one thing, this is the last time we got a 10% correction for that index after several years’ good run. Second, it is also August 16th that marked the trough of that correction and both Dow and S&P created new historical highs soon after. But will history repeat this time? Not so quick. And I’m going to explain below.

Other than well-known fundamental reasons (housing, financials…sounding familiar? These are exactly the same reasons causing the August sell off), there are some technical factors in play and how soon the market will come back to fundamental will more or less determine how the market will end in 2007 and even beyond. I will identify two main ones here(and there are a few minor ones but focusing on the main ones are more important): a). Unwinding of yen carry trade --- this is a hedge fund heaven trade for the past 7 or 8 years. As the interest rate in Yen is incredibly low(at one point even went negative, i.e. being paid for borrowing), investors borrowed in yen and then converted the Yen into other currencies(mainly US dollar) to purchase risky assets. This strategy has been working so well and actually some investors took it for granted that this strategy would work as long as the Japanese Central bank doesn’t raise interest rate aggressively (and to-date this hasn’t happen). In the meantime, they all happily collected the so-called spread gains between high yield assets and low yield loans. If they only use their own money to play then I guess this strategy may indeed work. However, those hedge fund managers were not satisfied with 5 to 7% spread yield and instead, they turned to a great tool that can potentially enhance their returns many folds. That’s right --- they employed the leverage to such a strategy. Once you are using leverage, risk can quickly get out of control and this is exactly what’s happening now. As investors are trying to sell their risky assets(read as commodities, equities) amid uncertainty, they suddenly find that so many people are trying to do the same, i.e. dumping risky assets and buying back Yen. In short, this yen unwinding trade has the potential to cause big swings in the financial market. b). Unwinding of so-called long tech and short financial trade. Since the August low, some hedge funds are betting tech would outperform the general market while financials would be lagging. And this strategy worked extremely well as the tech companies were indeed delivering better than expected results in general. However, as some funds have to raise funds to meet their yen carry trade margin call so they have no choice but to cover their long tech and short financial trade. The result is exactly what happened during the past few sessions: heavy selling in tech stocks and rebounding of financial stocks.

Both oil and gold prices dropped big today while the US dollar rallied from its recent low against major currencies (of course Yen is an exception). All emerging markets are sold heavily as some people are afraid the 2008 Beijing Olympic can repeat the Y2K event back in 2000. Although I agree this view has some merits, I don’t believe all apples taste equal. Right now investors are blindly dumping bad apples along with good ones (as can be seen by the highest VIX level in more than four years), so it may indeed provide some harvest opportunities for those well-prepared investors. Stay tuned!