- It’s a bit of a mess out there, so much so that it’s difficult to know where to start.
- But let’s begin with some currency news (apparently this remains a currency comment)
- Currencies, for the most part, shouldn’t behave like penny stocks. Unless they are currencies like the Zimbabwe dollar of the early 2000’s, or the Turkish Lira of the late 2010’s, or The Japanese Yen of the last 20 odd years.
- Perhaps a little context will help to understand recent market dynamics.
- In the 1990’s Japan got itself into some economic trouble, trouble that it couldn’t extricate itself from.
- Eventually they adopted the Quantitative easing playbook I.e. … slash interest rates to Zero (or below), and allow the Central Bank to purchase ALL the debt issued by the Government in order to drive long term bond yields to Zero (or below), in an attempt to stimulate growth, thereby trying to extricate themselves from 3 decades of stagnant economic performance.
- Of course, like everything in life, actions have consequences, and so these actions had predictable consequences for the global financial system, specifically with regards to what is known as the “carry trade”.
- In simple terms this is the process of borrowing money where interest rates are low, and simultaneously reinvesting those proceeds where returns are higher.
- When it works, there are 2 major drivers of Investor returns. Firstly, you achieve the differential between the 2 strategies. Borrow at ZERO, and reinvest at 10%, giving you a return of 10%. And if the currency you are borrowing in (or selling) does not strengthen by 10% against the currency you are Investing in (or buying) that return is very attractive. It’s even better if the Japanese Yen (in this case) weakens against your investment currency, then you get a double return.
- And so was born the Japanese Yen return strategy.
- Sell Yen (borrow at Zero) and invest in anything that has a higher yield.
- It could be another currency like the Mexican Peso (or Rand) where interest rates are closer to 10%, or even equities or some other asset.
- And as long as the Yen didn’t strengthen, your investment returns were almost guaranteed. And even better if the Yen kept declining in value.
- And the more people that follow this strategy, the more it becomes a self-fulfilling cycle. The more “Investors” there are selling Yen the more it weakens which in turn attract more and more people into the strategy.
- And this is one of the reasons for the current market turmoil.
- Because just like every “bubble” in history, from the great Tulip bubble of 1636, to the South Sea bubble of 1720, and the DOTCOM bubble of the late 1990’s (google is your friend), and every other Ponzi scheme in history – eventually there are no more buyers to entice, to the point where everyone, like spectators at a typical Man United game, rushes for the exits at the same time.
- And when there are only sellers (and no remaining buyers) the scheme rapidly falls apart.
- In this case the Yen strengthened by over 10% in a very short space of time, and the Investment currencies (or other assets) react in the opposite direction.
- One of the major beneficiaries of the Yen return strategy was the Mexican Peso. A Currency regime that offered 10%+ returns relative to the Yen. And for a few years the Peso strengthened on the back of this strategy.
- But when this all unraveled, those looking to buy their Yen back also needed to sell their Peso holdings, and so as the Yen strengthened, the Peso weakened by roughly 15% again in a very short space of time.
- Resulting in a circa (negative) 30% return for recent adoptees of the Yen return strategy.
- So why then did the ZAR also not weaken by 15%?
- Ironically – because of our own domestic malaise of the last 10 years, South Africa was not a major beneficiary of the YEN carry trade. When the scheme came tumbling down there was not much ZAR (unlike the Peso) in the system. Therefore, the Rand substantially outperformed the Peso.
- Also add in the fact that we have a semi functioning GNU and have not had load shedding for close to 6 months (in fact if reports are to be believed, Eskom is suddenly producing too much electricity), and therefore there is much more favorable sentiment toward South Africa as an investment destination.
- Speaking of sentiment and a semi functional Government. It is remarkable how quickly things are changing globally. A cursory glance around the world will tell you that things are not great.
- In the USA, the Democrats and the Republicans are trying hard to destroy the very fabric of the American dream. The UK is on fire, with both the Nationalists and the Liberals trying to outdo each other.
- The middle east is on the brink, and Europe is struggling to keep the Union together.
- For a change its quite comfortable to observe “relative” peace and quiet from the Southern tip of Africa – for now.
- But more about that in future publications.
- Yes, it’s a mess, but for once it’s not our mess.
- In fact, compared to what’s happening in the rest of the world, South Africa looks like the adults in global the room. – For now.
