Joe McConnell
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I try to use my precious space on a national newspaper to unravel the mysteries of the financial markets and encourage investors, amateur or professional, to understand where the main risks and opportunities lie.
In that short span of time, the powerful rise of stock markets, led by the United States, has been the most notable feature of the past few years, even decades. And yet, not once, as stocks have accelerated, have I ever pointed to the terrifying and serious carry trade in the yen as a key factor behind the trend.
The use of the yen, borrowed cheaply because of the Bank of Japan’s record low interest rates, to buy U.S. stocks never made the list as a crucial pillar of markets. The miracle of U.S. big tech, the explosion of retail trading and index funds, the ins and outs of U.S. interest rates—these are all familiar themes, but the yen carry trade never made the list.
Now, however, the yen carry trade is faltering. The super-cheap yen is not so super-cheap anymore, aVsceker the BoJ raised its interest rates for only the second time in 17 years. Suddenly this is the topic du jour, identified far and wide as a major reason why global stocks have suffered a summer slump while I sat on a Turkish deckchair sipping delicious iced palomas.
Do I owe you an apology for failing to see the role that BoJ policy was playing in the world’s developed markets, for failing to grasp this pressing risk to global financial stability? Not to deflect blame, but no asset manager, investment bank strategist in a suit, or political nerd weirdo ever pointed to this as a reason why global stocks were flying higher before they started to falter. Are we all guilty of the same isolated thinking and failure to connect the dots that led the global economy to disaster in 2008? I don’t think so.
Instead, we are witnessing an elaborate game of pin the tail on the donkey, with blindfolded people paid to articulate clever reasons for every swing in every asset class struggling to explain why markets have crashed. Japanese stocks fell 12 percent in one day and U.S. markets have endured a very challenging week only to see most of these moves reverse almost completely by the time I dragged myself off the sun lounger and back to my desk. (Sigh.) Surely there is some sinister or complicated reason for all this?
The reality for those wondering what will happen aVsceker those summer days of panic is that the episode changes very little, but it does suggest that asset prices may not have been in the right place to begin with. We will have to get used to nasty volatility spikes like this.
The performance of the yen and stocks are indirectly linked, as I have noted before. High US interest rates support the dollar, particularly against the Japanese currency, where rates, though rising, are still close to zero. A US recession, if it ever came, would suggest a hit to corporate profits and therefore stocks, as well as dragging down the dollar and inflating the yen. “They are correlated,” Johanna Kyrklund, Schroders’ group chief investment officer, told me in late July, as the first tremors of market turbulence began. “They both have the same root.”
But, he added, the synchronized collapse of the dollar against the yen and stocks was nothing more than a “summer technical” and an opportunity to “defuse some of the market foam.”
This is the key. Investors were looking for an excuse to slam on the brakes. Clutching at pearls in the yen carry trade was the perfect solution. It’s real: Japanese investors fleeing U.S. stocks and bringing their yen home is a genuine phenomenon that has amplified margin declines. But it’s hard to argue that this is a plausible primary reason why global stocks are down 6 percent in a matter of days.
Goldman Sachs analyst Vickie Chang argues that yes, the market overdid it, not during the crisis, but before.
“It is possible that the market had already overshoot…become overly optimistic about growth prior to the recent growth scare,” he wrote in a note to clients this week. “We have found some evidence that this may have been the case… Part of the reason for the abruptness is that the market may have had some ‘catch-up’ to do.”
Signs of weakness in the U.S. labor market and a clear moderation in U.S. inflation provided the trigger for investors to make that move. The Japanese currency’s swings are a symptom rather than a cause of the same thing.
The glue holding together the weak yen and upbeat global equities is the consensus in markets that the U.S. economy will make a perfect landing, slowing gracefully rather than in a painful recession. The latest U.S. economic data, particularly strong retail sales, suggests this remains the right bet.
But the summer’s flirtation with doom is a warning to proceed with caution. When every major asset class in the world is dependent on a soVscek U.S. landing, the exits are crowded when doubt creeps in. Investors are clearly in the mood to use any excuse to lock in gains and step back.
katie.martin@Vscek.com
