Since setting all-time highs in the first half of July, many global markets have rolled over in the wake of several newsworthy events.  Most notably, the Bank of Japan unexpectedly hiked interest rates on July 31, sending wake-up calls to groups of global investors who borrow Japanese Yen and use the proceeds to make investments in different assets around the world.  This is the so-called “carry trade” that many of you may be aware of or have heard discussed in the last few days.  The carry trade is a common occurrence where investors take advantage of borrowing in a low-rate setting (e.g. Japan) and deploying assets in a higher-return setting (e.g. US equities).

However, as with any use of leverage, shocks to the system like rising interest rates and re-valuing currencies changes the calculus for profitability and exposes traders to margin calls that often lead to hurried, and sloppy, selling to cover positions and limit exposure.  In this case, US equities have been the favored destination for much of these borrowed funds.  The result has been a fall-off in US equity prices and a rapid rise in the value of the Yen.  As more investors sold positions to cover their Yen short positions, the value of the Yen rose further, in effect squeezing those with remaining short positions and leading to a vicious cycle until all of these flows balance themselves out.

In addition to this global dynamic, economic releases last week showed a further slowing of the US economy, leading to calls for faster and deeper interest rate cuts from the Federal Reserve to stave off this weakness.  Naturally, this worsened the rout in US equities and the drop in US yields as many investors chose the safety of US Treasuries during this period of uncertainty.

While Nordwand remains watchful of these developments, we also note that it has been our view that parts of the US equities landscape were perhaps a bit over-owned and we have been focusing on opportunities in private markets, emerging markets, and credit/fixed income as areas that presented stronger risk-adjusted return prospects.  We continue to hold that view – although we would also point out that if this sell-off in US equities continues we expect to find more interesting opportunities arise and expect to communicate those as relevant.

We hope these comments are helpful in putting some context around recent volatility.  As with all things, personal circumstances and other factors will contribute to the appropriate portfolio allocation and investment selections.   We are here to be a resource and service, and would welcome the opportunity to speak with anyone about any concerns or issues with which we might be helpful.

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