Yesterday I thought I would begin this note with something like “Possibly the most significant development of the week was the rise in Japanese interest rates without the world ending.” As the Japanese stock market fell nearly 6% last night there is clearly a bit of unravelling to be done!
To avoid being too parochial I will still start with Japan, where for many months we have highlighted two upcoming problems.
The first is that the Nikkei has had a great rally up to 40,000, as the weak yen boosted the global exporters which are a feature of this index. This meant that when (not if) their interest rates went up, the yen would strengthen, their exporters would be less attractive, and the Nikkei would fall back.
The second problem is a global one. With rates near zero, global and Japanese investors borrowed vast sums extremely cheaply in yen, to buy a range of investments around the world, from higher yielding European bonds to US tech. The problem is that when Japanese interest rates go up, those investors will want to repay the loans – which means selling the investments which they bought with those borrowed funds. There is no evidence of this happening yet, and it will not be easy to spot in real-time, but we must be very wary of this risk.
The announcement this week was that the main interest rate in Japan will go up to “around 0.25%” from the previous range of 0% to 0.1%, which certainly doesn’t feel like a scary change. Initially the stock market went up by more than 1%, a very calm reaction. That changed last night, and the Nikkei 225 fell 5.81%...
…But the trigger wasn’t worries about Japanese interest rates shuffling up to 0.25%, rather the momentum began earlier in the day in the US.
On Wednesday the US central bank made it reasonably clear that they would begin to cut US interest rates in September, and markets responded positively. But on Thursday skittish investors lost their nerve. Poor results from some of the Magnificent 7 did not help, as they have single-handedly driven the S&P 500 higher this year.
Combined with the latter were the latest unemployment numbers. Last week I highlighted that some analysts believe the deteriorating jobless rate means that recession is a “certainty”. Yesterday’s figures then hit investor confidence, with something of a panic that the Fed is now too late to save the US economy – it was all very dramatic.
According to the Daily Telegraph headline this morning “Global stocks plunge amid fears of US collapse”. The reality was much more mundane. As I write the UKs FTSE 100 is down 0.6%, similarly France and Spain, and Chinese indices were down less than 1% overnight. While the Japan fall can fairly be called a “plunge”, it stood, or plunged, alone, aided and abetted by the yen issue.
What is going on from an investment perspective? The Goldilocks view of the world, which justified unjustifiable tech valuations and encouraged gearing-up in one currency to bet on assets in another, is unravelling.
It really doesn’t matter if there is a US economic recession. The problem for investors is a complacency recession in the US stock market. Even if the Fed cuts rates at its meeting four times on the trot, as some suggest is now needed, it won’t buoy deflated investors in S&P 500 ETFs who will be panicking to lock in profits before they disappear.
In the short term the volatility will be felt across most global equity markets, but those investors with time perspective will not take long to identify the opportunities – the money has to go somewhere after all.
Take Japan. The opportunity in large cap Japan was always limited in time by the eventual turn in the yen. Now those taking a longer view will likely concentrate on the extremely cheap opportunities in more domestically focussed small and medium sized companies, which are a multi-year “buy”.
UK equities were undoubtedly helped by the 0.25% rate cut this week, but this merely supported an already building positive mood in a market which is good value at worst, and cheap at best.
On cue, in this month's Dynamic Portfolio reviews there are updates for the UK and Japan, plus Dynamic World ex-UK, all delivering gains over their respective periods.
Dynamic Japan, reviewed every 3-months, had a mixed period but still managed a gain and is up an impressive 5x the index since inception. Do note that this portfolio is agnostic on types of funds – they might be Growth or Value, and small or large cap. Unlike UK, Europe and US, the smaller company funds are now rolled into the wider Japan Fund Sector.
It’s not a surprise to see Dynamic UK Blended doing well (up 13.4%) and beating the index over 6 months. It is up more than 1,000% since inception, which is more than 4.5x the index. As you will see when you click-through, the new selections continue to emphasise Value-style and small cap funds.
Leading this review cycle is the Dynamic World ex-UK portfolio, up 14.2% over six months and beating the index. As you will see, the latest fund selections show a clear shift in performance towards mid and small caps, as anticipated in an era of inflation volatility and where the emphasis switches to Value and away from Growth e.g. tech.
Lest we forget, it is also that time of the month for our What’s Hot? feature. In my experience UK funds have rarely dominated the top 3 spots in the Hot Funds over one month. Tech dominates the duds, having tanked even before last night’s sharp falls, and over the month China was also weak – but at least China is cheap, and just needs time and positive news to rebuild confidence. It is a similar story in the Hot Sectors, where US smaller companies also show positively, and with China dragging down three sectors.