Carry trade strategies in yen and the closing of investment positions after the decision by the Japanese central bank to raise interest rates, combined with concern about the momentum of the US economy after the release of July labor market data , which activated the “Sahm rule”, along with escalating tensions and uncertainty over geopolitical developments in the Middle East, led to a global sell-off in stock markets last Monday, increasing overall losses in last three weeks to 6.4 trillion dollars.
The CBOE Volatility Index, also known as the “fear” index (VIX), jumped as much as 161%, the highest level since the beginning of the pandemic in 2020, and despite efforts to balance prices in the short term, markets remain vulnerable. Analysts at JPMorgan Chase & Co caution investors that despite the correction there is little evidence that stocks have entered oversold levels as they did in October 2023. Investors should prepare for more volatility after the global sell-off -off, according to Goldman Sachs, considering that although the correction is stabilizing, it shows that it is not complete.
Fluctuations
When the Bank of Japan suddenly raised interest rates on July 31 to 0.25%, the highest level since 2008, and its governor, Kazuo Uedasaid he intended to continue the hikes, sparked a sharp rise in the yen and wild swings in international markets. In recent years, moreover, it has been common for many investors to borrow at zero interest rates in yen, investing in assets in other parts of the world with higher yields (“Yen Carry Trade”), but also in stock market instruments that yielded greater profits through leverage. .
The closing of some positions by large portfolios, at the mercy of rising interest rates, intensified the global sell-off, while the yen strengthened against the dollar, forcing some hedge funds to close their positions. 2024’s top-grossing positions range from Japan’s Nikkei (-12.40%) index, which posted its worst day since the 1987 crash on Monday, to the ‘Magnificent Seven’ high-tech stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia , Tesla, Meta), Bitcoin and the cryptocurrency market crashed, while Berkshire Hathaway’s Warren Buffett announced it was halving its stake in Apple, while the Japanese yen, which fell to a 38-year low earlier, surged to seven-month highs against the dollar.
Thus, last Wednesday, the deputy governor of the Bank of Japan (BOJ) Shinichi Uchida sent a new, softer message in the wake of historic volatility in financial markets, saying the central bank would hold off on further hikes while markets remain volatile, although analysts expect one more hike before the end of the year.
The bank, he noted, will take the overall market situation seriously into future policy decisions, while analysts commented that “the BOJ raised rates because it didn’t like the weak yen, and now appears to be suggesting a pause in hikes because she doesn’t like stocks falling.” At the same time, another factor that contributed to the global sell-off of the last few days is the invocation of the so-called “Sahm rule”. It is a formula named after the American economist Claudia Sam and predicts that when the average unemployment rate for three consecutive months exceeds by at least 0.5% the previous 12-month low then it is only a matter of time before the US economy slips into recession.
The measure hit 0.53 in July, according to unemployment data released on Aug. 2, signaling the start of a recession, spooking investors as the “Sam Rule” has predicted every recession since the decade ’70 until today. Goldman Sachs analysts estimate that the chances of a recession do not exceed 25%, while UBS economists are convinced that the US will avoid a recession, as the US economy is still on a soft landing trajectory, with the Fed even proceeding with a reduction of interest rates by 50 basis points in September. Morgan Stanley also expects a “soft landing” of the American economy, noting that investors should prepare for the upcoming (from September) interest rate cuts by the Fed.
Recession fears are overblown, BlackRock also said, while high-risk assets could recover as interest-rate advantage strategies stabilize, as several investment funds borrowed in yen convert into dollars and other currencies now that the BOJ raises interest rates, they are now closing their positions. For UBS, the appropriate investment strategy today involves exposure to quality medium-term bonds and quality equities, with gold and the Swiss franc providing portfolio hedging, in an environment of increased geopolitical risk.
Interest rates
For the market, an important question is how the Fed will move now. Traders are now pricing in an 84% chance it will cut interest rates by 50 basis points in September, while Citigroup economists now believe the Fed will try to move benchmark rates back to neutral levels sooner. Instead of 75 basis point rate cuts this year, it now expects a total cut of 125 basis points, with cuts of 50 basis points in September and November and then 25 basis point cuts until rates reach 3%-3.25% in mid-2025.
How should investors move now? For Citigroup, its checklist that shows whether the markets are entering a Bear Market (long-term bear market) shows that 8.5 of the 18 total parameters it examines are in the “red”, which points to market weakness, but as the list of negative parameters is not in double digits, it recommends positions in price drops and especially if the markets show signs of stabilization.
Greece
As for Greek shares, which have partially recovered from Monday’s €6.5bn losses, Alpha Finance sees valuations remaining attractive, with the General Index, which it sees room for above 1,550 points, trading based on an earnings multiple (P/E) of approximately 8.5 times, i.e. at a 40% discount compared to the historical average and a 30% discount compared to the European Stoxx 600 index (30%) and 21% to relative to the MSCI EM emerging market index.
Energy is the focus
Geopolitical risk and oil prices
Escalating conflict in the Middle East is increasing the geopolitical and geoeconomic risk premium in the markets. According to data from Citigroup, however, stock markets, despite the initial volatility, usually move higher 12 months after the start of geopolitical conflicts, but fall significantly when geopolitical risks lead to energy crises, such as during the 1970s Yom Kippur War and during Russia’s invasion of Ukraine which sent gas prices skyrocketing. So investors should focus their attention on the energy sector.
Although at the start of the new escalation in the Middle East the price of oil fell as investors priced the risk of recession more than the risk of war, in recent days prices have recovered slightly as markets remained alert to the possibility of a retaliatory hit by Iran on Israel, but mainly due to a sharp decline in US crude inventories for a sixth straight week by 3.7 million barrels to 429.3 million barrels and lower production at Libya’s 300,000-barrel Sharara oil field per day that raised concerns about supply shortages.
Recommendations
Brent, from the July 24 high of around $88/barrel, is however moving to $78/barrel, close to the seven-month low ($76/barrel). Weather, geopolitical developments and financial flows could temporarily support prices, reports Citigroup’s commodities division, however, recommending sales in the event that black gold exceeds $80/barrel, levels which for analysts at the US of the bank cannot be supported on the basis of fundamentals. Although there is the possibility of an escalation of conflicts in the Middle East with the risk of an Iranian counterattack in the near future, Citigroup analysts believe that Israel would not attack e.g. Iranian oil assets, including export terminals (Kharg Island, through which 90% of the country’s oil exports are channeled, is a vulnerable spot in Iran’s oil infrastructure), in the midst of an election cycle in the US, although miscalculations will could potentially lead to unpredictable escalation. On the other hand, if the US eventually falls into recession, historical data from the last 60 years shows that the prices of black gold balance in the region of 60 dollars/barrel.
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