by Ivan Martchev
July 30, 2024
One of the largest carry trades in the world, funded by the Japanese yen, has reached some sort of climax and is partially unwinding, which is sending ripples through stock markets in both Japan and the U.S.
That means we find ourselves pondering the centuries-old conundrum: Which came first, the chicken or the egg? Some say the unwinding of the yen carry trade reflects some weakness in the global stock benchmarks, sending the yen higher, but I beg to differ. I believe it is the other way round.
As of Sunday July 28, the Nikkei 225 Index has been down in nine out of the last 10 trading days, as the Japanese yen has rallied by almost 5%. The Nikkei 225 loves a lower yen, as the Nikkei index is full of exporters that get a profit boost when the yen depreciates and they repatriate the earnings back to Japan, but any sharp upward moves in the yen tends to pressure the index, as it has done in the past two weeks.
The problem with the yen is that it has been used to buy other assets, be it stocks, bonds or anything with a higher yield, and that is likely to appreciate as the carry cost has been miniscule. The Bank of Japan (BOJ) policy rate just flipped from -0.010% in March of this year to a positive +0.010%. The BOJ rate spent eight years in negative territory and the attempt to normalize rates in Japan is causing volatility.
Note (in the chart below) that there was another sell-off in the Nikkei 225 (and S&P 500) after the BOJ hiked rates and March. Both indexes bottomed out in late April. The BOJ has not hiked rates yet, but the yen is moving sharply in anticipation. (When the yen chart points down, that means a higher yen, as it means fewer yen per dollar). The July low in the yen is 161.94, while the high last Thursday is 151.94.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Keep in mind that as non-Japanese financial institutions are borrowing in yen in order to buy assets outside of Japan, this is identical to putting on massive yen short positions. They have to borrow the yen, sell it for the currency of the asset they are trying to buy and enjoy the appreciation or higher yield (or both) of the foreign assets, so borrowing yen is equal to shorting yen for foreign players outside of Japan.
If the yen is rising sharply because of anticipation of the upcoming BOJ rate hikes, it can create a short squeeze that ripples through the carry trades, as it is doing at the moment.
Practically, not many institutions could borrow yen at -0.010% unless they are part of the BOJ system and deal directly with the Japanese central bank. But large global financial institutions that operate within Japan can borrow in the Japanese inter-bank market, which this year saw the inter-bank lending rate go from 0.08% to 0.36% (and likely headed higher) as the BOJ normalizes monetary policy in baby steps.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This brings me to the NASDAQ 100 Index, which is the epicenter of the drama on our side of the pond, over the past two weeks. Unfortunately for tech investors, there is a strong correlation between the Nikkei 225 Index and the NASDAQ 100 Index (see chart above), and I am afraid that the U.S. tech sector has been the beneficiary of yen-funded carry trades, which are now partially unwinding. The simple fact is that it was not the news driving the selling but algorithms unwinding the carry trades. That’s because the leverage in such unwinding tends to create faster and sharper sell-offs than any normal “news” could possibly create.
If the BOJ does not shock us this week with a rate hike and/or the Fed shocks us with a rate cut this week, I think we are in store for a bigger rebound, both in the Nikkei 225 and NASDAQ 100, simply as a form of mean reversion. Good earnings may also help the rebound, as we are in the middle of reporting season.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The more extreme example of the present rotation is the convergence of returns between the NASDAQ 100 Index and the small-cap Russell 2000 Index. In July, the NASDAQ 100 lost almost half of its previous gains for the year, while the Russell 2000 zoomed higher, as the tech drama unfolded. My guess is this rotation will continue, although probably not in as extreme a fashion as has been happening in the past two weeks.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
If you find yourself wondering if the stock market is on a firm footing, or if there is trouble on the horizon, it is always a good idea to keep an eye on the financial sector. The regional banking sector just closed on Friday at a new high for the year. Regional banks were the prior Achilles Heel of the market, given the fiasco with Silicon Valley Bank and the related takeover of First Republic bank last year, and other less dramatic regional banking issues. It is fair to say regional banks love the coming Fed rate cuts.
There is one company that I believe is a stock market indicator, in and of itself, given its dominance in capital markets. That company is Goldman Sachs (GS). You cannot see the July S&P 500 sell-off reflected on a Goldman chart, nor can you see the April sell-off reflected there. All you see is a mild pullback into short-term moving averages. None of this means we cannot see more volatility coming in September and October, similar to last year – particularly if the yen makes further sharp gains – but right now it means that all we have witnessed is a violent rotation into the value part of the market.
Navellier & Associates does not own Goldman Sacks (GS), in managed accounts. Ivan Martchev does not own Goldman Sacks (GS), personally.
All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
The Case for Cutting U.S. Interest Rates This Week
Income Mail by Bryan Perry
A Bottom in Commercial Office Property Values Now Looks Further Out
Growth Mail by Gary Alexander
The American “Income Gap” is Much Smaller Than Advertised
Global Mail by Ivan Martchev
The Yen Strikes Back
Sector Spotlight by Jason Bodner
Managing Change in Markets Can Be Stressful – But Profitable
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Ivan Martchev
INVESTMENT STRATEGIST
Ivan Martchev is an investment strategist with Navellier. Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev
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