Why

I have been asked quite a few times why seeming seemingly unaffected assets are being hit so hard by the tragedy in Japan. While nobody knows for certain why markets do what they do, I will hazard a guess. As a result of 0% interest rates in Japan many Japanese engage in carry trades, because they cannot get any income on domestic assets. These carry trades also happen to be part of the "risk on" trade, and the Japanese are now fleeing to safety.

Many investors carry out momentum strategies which exacerbates these movements. On top of that many hedge funds carry out momentum strategies while calling it a different name. They call it "risk management", which means they sell positions once they start going against them. Add to that the recent rise in leverage and the margin clerk starts getting into the act.

This creates pockets of value for those who were not overly committed heading into this crisis.  That said its difficult to know when the vicious circle will end and there might be yet better prices first.

1 comment:

revelo said...

A simpler explanation is that investors are coming to their senses about risk. Bad stuff happens in life, and the equity holder is in the first loss position. Stocks are not a bargain just because they offer a higher return than bonds. To be a bargain, stocks must offer both a higher return and a margin of safety, and that isn't true even after the recent declines. The only reason stocks haven't fallen more due to the Japan disaster is that investors rightly anticipate a second tsunami of money from the central banks.

Since you are a die-hard inflationista, I'll grant you this. About 3 years from now, the deflationary pressures will stop and inflation will finally be a true threat. Even then, we still won't get true inflation, but rather higher real interest rates due to still another tsunami, this time of money returning to the central banks as they sell their massive bond portfolios. This will crush every asset class except cash. Intermediate bonds are the place to be in the interim, gradually shortening maturities as we approach the day of reckoning.