That’s what the CIO (my boss’s boss’s boss) as I was making the transition from securities analyst to full-time portfolio manager in the mid-1980s said most often. His second favorite remark was not to waste time on the +10% ideas. Concentrate on finding the +30% and +50%s. (I’d modify that by saying that once you’d found the latter, it’s ok to fool around with the former. It’s like batting or fielding practice–it keeps your head in the game.)
During the first half of 2024, NASDAQ gained +25%. The S&P peaked a couple of weeks later at close to +20%. Both would be fabulous results for just about any full year. Easy to say in hindsight, but these numbers themselves argue that, for a while at least, sideways would be the best one could hope for …and sideways almost never happens. So a drift down was in/on the cards. Actually, that was the best case scenario.
We got that for a while, but then the bottom dropped out with a sharp lurch downward yesterday.
the carry trade
The carry trade is a form of arbitrage, the “carry” being the income gained from holding a position minus the cost of doing so. For some time, the most straightforward strategy has been to borrow (or sell short) in Japanese yen and use the proceeds to buy US Treasury bonds. The yield on the Japanese bonds you short is about 1%; the 10-year Treasury is around 3.8%. So if nothing changes, you pick up a “free” 2.8% or so.
Although bond to bond is the simplest arbitrage, you can also do something more complex, like shorting a Japanese stock index or individual stocks or the yen and buying some other mix of currency/index/stocks.
Japan is the ideal thing to short, because the country has been an economic disaster for more than three decades (following an anti-woman, anti-immigrant, anti-foreigner, anti-men with hair on their faces, pro-samurai policy, grounded in the idea of Japan’s uniquely favorable relationship with the divine, that sounds eerily like the MAGA platform here), So while there would be the chance of a gain from long Treasuries as the Fed lowers short rates, if form runs true there should be little chance of an economic pulse in the Land of Wa.
the practitioners: the banks …and private equity?
In my view, the masters of currency-related trading are the international banks. I always thought of myself as part of the dumb money in the currency arena, although I’d really like my chances if the main competition were private equity. My guess is that private equity was the trigger for the ructions of the past two days.
what happened?
There seems to have been a mass liquidation of long $US-, short yen-related arbitrage positions. The trigger was the Japanese central bank raising short rates from zero to 0.25%. I don’t know, but I find it hard to believe that this had any dramatic effect on major international bank positioning (I don’t include Japanese banks in this category). This leaves computers and relative amateurs as the culprits.
where to from here?
Who knows? I’m often (always?) too optimistic, but my idea is that this is that forced selling from yesterday washed a significant amount of speculation out of global markets. If so, this is a time to look for babies thrown out with the bath water, in what will likely be a sideways market.
I don’t have much desire to add to my tech exposure, which is already pretty significant. I’m shopping for steady growth, a reasonable PE and maybe even a dividend yield instead–downtrodden value stocks, in other words. I’m a little surprised that I’m doing this, but it’s what I find most attractive at the moment.