Read the previous week’s Investment matters.
Background
Global equity, currency and bond markets experience some gyrations over the past week. Headline movements in Japanese equities, large moves in currencies and sharp falls in equity markets in Australia and the US hinted at significant changes in either positioning or fundamentals.
A weak US employment report on Friday 2nd August added to the level of uncertainty.
For market participants the principal task was determining whether the level of dislocation was indicative of sharp changes in a relatively narrow set of conditions, or whether concerns were much broader and more permanent.
By the end of the week the outlook was much clearer and markets across the globe recovered much of their losses. This was especially the case in Australia where the markets are now only slightly down a year-to-date basis. More importantly measures of uncertainty such as the US VIX index of volatility had fallen 60 per cent from the highs of Monday.
The Market
So what happened? From our perspective two changes occurred, one was the unwind in the Japanese carry trade, and the other was the continuation of a rotation in the types of stocks that are supported in global markets. Both are relevant to client portfolios.
What was the Japanese carry trade and what changed? Over the past three months, as global markets rose, recession concerns abated, and the outlook for more persistent inflation became intrenched, the outlook for rising Japanese interest rates became more certain.
In late July the Bank of Japan raised interest rates to levels unseen in 15 years. The chart below shows that official policy rates had become meaningfully positive, at 0.25%. Instead of negative or zero rates, the cost of money in Japan was no longer FREE.
Source: Reuters
Readers may be sceptical that rates so low changing by so little could create havoc. But rates in Japan had remained nearly “free” for fifteen years, and for the last 2 years despite inflation rising above 2%. The BOJ has let inflation rise partly due to Japanese inflation being relatively low compared to the rest of their major trading partners, and partly due to the need to create some inflation in Japan after a decade of flat to falling prices.
But the decision to make rates positive by the Bank of Japan, along with the announcement of other measures to phase out actions designed to keep interest rate near zero had vast implications for those that assumed free money would continue, those engaged in the “carry trade”.
Global investors had borrowed in Japan (at zero cost), paid a relatively small amount in fees to cover the risk of exchange rate movements, and then invested the funds in dividend or income paying assets elsewhere in the world. Some had even used this “free money” to invest in more speculative tech and momentum stocks. The exact amount invested in this carry trade strategy wasn’t completely clear, nor was the quantum invested in bonds or stocks, high risk or low risk etc.
By the beginning of the week however, it was clear a large number of players need to unwind this trade, the implication was;
- Higher value of the YEN, as people purchased YEN to pay back the money borrowed from Japan
- Lower value of stocks in Japan as higher currency and higher volatility crimped future return expectations
- Lower equity value around the world as people sold assets to repatriate funds to Japan
- A flight to safety including to bonds and gold as investors were uncertain how long the unwind of the carry trade would take.
By mid-week the market had a sense the unwind would be relatively well-managed, and by the end of the week uncertainty had tempered.
We saw some recovery in the value of Japanese stocks, especially in AUD terms. This is critical to our clients as we have an increased exposure to unhedged Japanese equities. In fact, despite a reduction in the Nikkei 225 index of almost 11 per cent since June, the YEN has appreciated by almost the same amount (+10.5) resulting in our clients Japan position returning a small negative amount since June.
The rise in gold had somewhat reversed, but some critical impacts lingered, its impact on stock rotation. The sell-off in the higher priced and higher momentum stocks didn’t fully reverse. The best example of this is the year-to-date fall in the tech heavy NASDAQ of 6 per cent versus the boarder US market of only 2.5 per cent.
At the extreme end the so-called Magnificent 7 stocks (MAG), including Nvidia, Microsoft, Apple, and Amazon, have now reversed all of the gains since mid-May (shown in the chart below). We have avoided excess exposure to these positions and have missed both the peak and the collapse.
The smaller part of the US market, the so-called S&P400 which clients own in the iShares Mid-Cap ETF are up almost 1 per cent since June, a 7 per cent difference in just over one month.
The rotation away from momentum and larger companies had begun. It is consistent with the way we have been positioning our client portfolios, and consistent with an economic outcome that sees stable rates, moderate inflation, and the removal of the final effects of the global free money trend which began more than 15 years ago.
Trimming our Gold Exposure
One of the lasting impacts of the movements in recent months includes the spike in gold prices
Gold has been having a charmed run. It rallied as US real yields fell from 2019 to 2022 as is usual when it’s behaving as a currency. But the correlation broke as real yields started to rise. The break came as Russian FX reserves were seized after the invasion of Ukraine. As a result, gold stopped trading as a currency and benefited from an independent safe-haven bid. But now gold has set a new all-time high on a weekly close basis as the weak macro data saw US real yields start to fall (Figure X).
Gold stocks have benefited from the rise in the gold price over this period. Most First Samuel investors have a stake in Newmont Mining, the US-based mining company which is the largest Gold miner in the world. After completing the takeover of Newcrest Mining, the biggest gold miner in the Australian market in mid-2023, the new combined entity was launched on the Australian market in October as a Chess Depositary Interest (CDI) which allows a foreign company to be listed on the ASX. However, given the lower portion of the combined entity which remained in Australian investor hands and that the primary source of investor liquidity resided offshore, the former standalone Newcrest was dropped from its ASX index weightings, from which asset manager mandates and benchmarks are often derived, to sit outside the top 100 stocks. This technical adjustment, drove index-focussed funds and Exchange Traded Funds (ETF’s) to sell down their stock holdings accordingly and placed significant pressure upon the Newmont share price in the latter part of calendar 2023.
We used this opportunity to add to our holdings in the stock, believing that gold exposure remained a critical portfolio position and also recognising that Newcrest was a significant company with high quality, long-dated assets with excellent prospects.
Source : Minack Advisors
We’re fortunate that this call has been the right one, with the stock rising about 50% since the lows of February 2024. Accordingly, we’ve taken the opportunity to trim investor holdings in Newcrest this month.
ASX reporting season
Most companies who have an accounting year-end date in June, select August as the month to report their full year results. We’ll provide updates in Investment Matters over the course of the next few weeks. Here’s a snapshot of results reported in the week just past for stocks held within client portfolios
Mirvac (MGR)
Real estate stocks finished in the red on Thursday after property developer Mirvac forecast lower earnings and distributions in the 2025 financial year as higher costs eat into margins on residential projects. Mirvac’s own shares tumbled 9 per cent to $1.92, with FY24 settlements of 2400 lots being the lowest level for almost a decade as First Home Buyer demand in Sydney and Melbourne remains subdued.
We believe Mirvac is well placed to exploit medium term opportunities that remain in the changing landscape of Australian residential development. Whilst the cycle can be hit and miss, the enduring value they are creating remains attractive.
IGO
Fell 2.5 per cent on announcing its result (recovering 1.1% next day), after the miner announced that it was considering divesting some of its nickel assets. The company signed an agreement with Medallion Metals where the latter may pick up the Cosmic Boy processing facility and associated infrastructure at IGO’s Forrestania nickel project. We regard this as a disappointing development as we hold the stock for its exposure to nickel, is regarded as an important, low cost metal in the energy transition needs of the global economy (eg construction of solar panels, wind turbine and nuclear energy generation of electricity).
QBE Insurance
On Friday delivered an 1H24 result which failed to meet consensus expectations, with the stock falling 3% in response. Despite a strong uplift in profit (92% on pcp), Return On Equity (6.8%) and dividend (71%) the outlook statement from the company was more subdued, with increasing evidence of portfolio reserve releases required to drive Gross Written Premium (insurance terminology for non-investment portfolio revenues) growth while the broader franchise is de-risked. Additionally, the dividend this period, despite being well up in absolute terms, was well below broker expectations, prompting questions about why the company is continuing to retain capital levels in this manner. Management however indicated that the 2H dividend should be a step higher again, allaying fears of pending undisclosed risks as the source of dividend conservatism this period.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.