Three weeks ago, I signed off for my annual summer break. When the markets went doolally a couple of weeks ago, I got a plaintive appeal from my editor at Reaction whether I could please cobble together an opinion piece which I duly did. I didn’t switch on any screens and just reminded readers that this sort of thing happens periodically at this time of year and not to get too excited.
Had I been away in a spaceship for the past fortnight and a bit, had I just returned to Planet Earth this morning and had I compared market levels to where they had been on, say, 1 August, I would find the Dow Jones to be up by 120 pts, the S&P500 to be 32 pts higher, the Nasdaq to be up by 30 pts, the FTSE to be off by 50 pts, the Dax off by 180 pts or 1% and the Nikkei at Friday’s close also to have been within spitting distance of where it had begun the month. The US 10-year Treasury note is now trading at a yield of 3.88%, a little less than 10 basis points lower than it was at the beginning of August, but is that a surprise with markets still expecting something of a rate cut by the Federal Reserve? The 2-year/10-year yield curve, meanwhile, remains stubbornly negative. Gold looks steady above US$ 2,500/troy ounce and there’s nothing seriously wrong with Brent Crude at or around US$ 80.00 pbb. Sure, the Japanese yen has been strengthening from its silly low of over ¥ 160/US$ but, at the beginning of August, it was already at ¥ 149 and its now at ¥ 146.
Where’s the big deal?
Actually, there is one but it’s not what most people think it is. The big deal was in the so-called “yen carry trade”. It has nothing to do with investing but is, as the name reveals, a trading tool. Yen interest rates have since time immemorial been nailed to the floor by the Bank of Japan so borrowing really cheap yen and buying higher-yielding dollar assets has been a bit like shooting fish in a barrel. The “carry” is the difference between the cost of money and the return. The risk is in the exchange rate since carry trades, by necessity, are left unhedged.
Banking 1.0.1 teaches us that the forward exchange rate between two currencies is not a speculative thing but a simple bit of arithmetic that captures the interest rate differential. Markets are never entirely perfect but, in theory, the box trade – that’s borrowing in one currency to finance an asset in another one with the currency risk hedged out to the maturity of the asset – is a zero sum. With yen interest rates at near to zero and with the currency weakening against the dollar as the Bank of Japan appeared reluctant to raise rates, hedge funds were piling in like there’s no tomorrow. Then the market was caught by an anxiety attack that the American economy was about to fall off the cliff, that the Fed was about to slash rates left, right and centre while the BoJ was about to tighten, and the benefit of the cheap borrowing and strong positive carry would be wiped out by the concurrence of a rising yen and falling dollar.
Panic ensued and, as I had suggested in my short piece for Reaction, the youngsters who had been left in the office to mind the books through the dog days of August with the instruction to do nothing but in the event of a crisis to flatten the books had done just as they had been told. That they all did the same thing at the same time and into a thin market with next to no buyers was what caught them out. Not their fault. That the old barrow boys who didn’t care whether they were buying and selling potatoes, second-hand cars or second-hand stocks and shares have been evicted from the City and from Wall Street and replaced with Harvard, Wharton and INSEAD MBAs with CFAs and CAIAs does not alter the fact that trading is a blood sport where AI, artificial intelligence, might look good but where RN, real nerves, remain. It was the now 94-year-old Warren Buffett, the Sage of Omaha, who declared that he likes to sell when everyone else is buying and to buy when everyone else is selling. That requires guts and not algorithms. I could go on.
Alas, the panic is over and whoever did nothing and instead enjoyed watching the Olympic Games is in good shape. That said, the autumn ahead will be tricky, that is sure. The current lack of economic certainty – one week it’s all about recession, the next it’s not – and the added shifting sands of geopolitics make forecasting what will drive markets between now and the end of the year as good as impossible. The collapse in early August of faith in the yen carry trade – its being put on again – was a stark warning to take nothing for granted. Between 10 July and 7 August, Nvidia fell from US$134 to US$98 and then bounced back to close on Friday at just under US$125. Too little thinking costs money, but then so does too much.
So off we trot into a new week. Markets will remain thin and skittish until at least a week or ten days after Labor Day which this year falls early on 2 September. Not much that happens in markets between now and, say, 10 September ought to be taken too seriously, although not too seriously and not at all seriously are not one and the same. For years, I ended my Monday column with the reminder to investment managers that their clients can’t pay a bill out of index performance but only out of money made and not lost. Please write that on a Post-it note and stick it on your screen.
Write to us with your comments to be considered for publication at letters@reaction.life
