Over The Pond – Up is Down: “He’s rocking the ship!”
Written by Julian Wheeler – Partner and US Equity Specialist
In the third of the ‘Pirates of the Caribbean’ series of films – At World’s End – one of the most memorable scenes is where Capt. Jack Sparrow solves the riddle of ‘Up is Down’ and starts to rush from one side of the ship to the other, enticing the crew to do the same until the rocking motion caused by their combined weight lurching to and fro is sufficient to cause a capsize as he intends. ‘Captain’ Trump may not have the same intention, but his zigzag actions are having the same effect on investors in the market. A lightning three-day bout of selling produced a 10% decline, swiftly followed by a gain of almost twice as much over the following month as the absurdity of economy killing tariff rates were quickly rescinded.
Last month I mentioned how fund managers had shifted from a robustly overweight stance on US equities, to an almost emaciated underweight in a record-breaking short space of time. My suspicion is that many of them have performed a rapid scramble across the deck to reverse that position following Trump’s policy flip-flops. We sailed relatively calmly through the Q1 corporate profit season, because if anything there was a boost to activity ahead of these tariff introductions. The potential trouble will only make itself felt in July when we get Q2 numbers along with the intended completion of the tax bill. July 4th this year may well be full of fireworks of a financial kind.
So now we are back where we started on the indices, does that mean that everything is all ok then, no panic necessary, the danger has passed? Err, no. Not so fast according to the bond market, which is suggesting otherwise. Trump is causing some very queasy stomachs for fixed income investors, who are now demanding a much higher yield to be persuaded to continue to own US Government debt. The concern is around the impending Tax Bill, which if passed in its current form will place a huge strain on the budget deficit by extending Trump’s original tax cuts that were due to expire.
Japan, in total contrast, has a Prime Minister who has expressly rejected calls for tax cuts, highlighting the effect that they would have on the already enormous deficit and perhaps wishing to avoid a ‘Liz Truss moment.’ However, by being so brutally honest as to suggest that Japan’s dire financial condition (over 250% Debt/GDP) is much worse than that of Greece at the height of the 2011 credit crisis, he may have caused as much damage as any tax cut, by sending long bond yields to their highest level in a generation.
For the last 30 years, attempting to sell Japanese bonds in the face of the Bank of Japan buying them has becoming something of a gruesome joke in investment circles and is known as the “widow maker” trade, destroying many traders who have tried to bet on this move to higher interest rates. But it is now finally happening and that bet would finally have paid off. If you went short the 30-year Japanese bond since the beginning of this year, you would have gained about 30%. Unsurprisingly, holders of these assets are rushing to unload them or facing an equivalent loss on a mark to market basis.
This sort of movement in a usually stable asset is unsustainable and something is going to give…..I just don’t know exactly what and when! But my best guess is that you will see it unwind in the value of Dollar/Yen (currently around 144) as the global ‘carry trade’ which has existed for years – borrowing very cheap Yen and investing in Dollar assets is now at an end for the time being at least: Mrs Watanabe (the accepted collective term for Japanese retail investors) may well think it is time to bring her money home. Japan is the world’s largest owner of US Treasuries. Donald Trump has said he wants a lower dollar – well, he might just get it in a hurry.
Baton down the hatches: we may be about to see another lurch across the decks from the ‘Buy’ side of the ship to ‘Sell’.
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