The summer shift in the markets reveals the excuses to sell

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I try to use my valuable space in a national newspaper to demystify the financial markets and encourage investors, amateur or professional, to understand where the key risks and opportunities lie.

Within this short, the strong rise of the US-led stock markets has been the most notable feature of the last few years, even decades. And yet, not once, while stocks have rallied, have I ever pointed to the scary, serious trade in the yen as a key factor behind the trend.

Using the yen—borrowed cheaply from the Bank of Japan’s very low interest rates—to buy US stocks just never made the list as a crucial pillar of the markets. The great tech miracle in the US, the boom in retail and index-tracking funds, the downsides of US interest rates – these are all well-trodden themes, but the yen trade never came up.

Now, however, the yen trade is faltering. The super cheap yen isn’t so cheap anymore after the BoJ raised interest rates for only the second time in 17 years. Suddenly, it’s the talk of the day, widely identified as one of the key reasons why global stocks suffered a summer tumbling while I sat on a Turkish lounger sipping delicious iced palomes.

I owe you an apology for failing to identify the role BoJ policy was playing in the world’s developed markets, for missing this pressing risk to global financial stability? Not to deflect blame, but no asset manager, thorough strategist at an investment bank or die-hard policy geek has ever pointed to this as the reason why global stocks soared before they began to stumble. Are we all guilty of the same 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 tail on the donkey, with blindfolded people paid to articulate intelligent reasons for every wobble in every asset class, struggling to explain why the markets crashed. Japanese stocks fell 12% in one day and US markets suffered a very difficult week only because most of these moves were almost completely reversed by the time I got off my lounger and back to my desk . (Sigh.) Surely there is some sinister or complicated reason for all of this?

The reality for those of us wondering what comes next after those panicky summer days is that the episode changes very little, but suggests that asset prices may not have been in the right place to begin with. We’ll have to get used to nasty volatility spikes like this.

The performance of the yen and stocks are indirectly linked, as previously mentioned. High US interest rates support the dollar, especially against the Japanese currency, where rates, while rising, are still close to zero. A US recession, should it ever land, would suggest a hit to corporate earnings and therefore stocks, as well as drag down the dollar and yen. “They are correlated,” Johanna Kyrklund, chief investment officer at Schroders, told me in late July, when the first tremors of market turmoil began. “Basically they both have the same root.”

But, she added, the synchronized drop in the dollar against the yen and in stocks was really nothing more than a “technical summer job” and an opportunity to “blow some of the foam out of the market.”

That’s the key here. Investors were looking for an excuse to hit the brakes. Pearl-picking about the yen exchange was a perfect fit. It’s real – Japanese investors fleeing US stocks and bringing their yen back home is a genuine phenomenon that has amplified margin declines. But it’s hard to argue that this is a plausible primary reason for global stocks to drop 6% in just a few days.

Vickie Chang, an analyst at Goldman Sachs, suggests that yes, the market went too far, not during the shakeout, but before it.

“The market may have already exceeded . . . become too bullish on growth ahead of the recent growth scare,” she wrote in a note to clients this week. “We’re finding some evidence that might have been the case. . . Part of the reason for the sudden changes is that the market may have had some ‘reduction’ to do.”

Signs of weakness in the US labor market and a clear moderation in US inflation provided the trigger for investors to make the move. Japanese currency swings are a symptom rather than a cause of the same.

The glue holding the weak yen and bullish global stocks together is the market consensus that the US economy will make a soft landing, slowing down gracefully rather than into a painful recession. More recent US economic data, particularly robust retail sales, suggest it remains the right bet.

But summer’s flirtation with doom is a warning to proceed with caution. When every major asset class in the world is banking on a US soft landing, the exits are crowded when doubts set in. Investors are clearly eager to use any excuse to lock in gains and take a step back.

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