Some rising market risks to watch out for in the second half

The conditions that contributed to the August 2024 market shock, including a crowded yen carry trade, stretched technology valuations, and elevated leverage, are beginning to reemerge. The rapid growth of leveraged ETFs has introduced a relatively new source of market risk that can mechanically amplify both rallies and selloffs. Investors should watch the jobs report, yen strength, and volatility measures for clues that deleveraging is beginning. On a recent walk along the waterfront near my home, I noticed a yacht in the marina with the name "Leverage," a not-so-subtle reminder that many fortunes are built on borrowed money, labor and technology. It is not always a one-way ticket to success though. Investors use leverage to amplify returns but it also can increase losses. When too much leverage builds up in a particular market it has the potential to create volatile swings in prices if that leverage is quickly unwound. Furthermore, such an unwind in one market can reverberate into others, a butterfly effect that can stretch from Tokyo to New York. We saw such an unwind in early August of 2024. Similar signals seen the weeks before that event are popping up now, a sign markets are more vulnerable to a market dislocation than usual. On August 5, 2024, Japan's Nikkei 225 index fell 12.4%, its worst single day drop since "Black Monday" in 1987 following the unwinding of leveraged positions and carry trades. This flash crash reverberated into U.S. …