Friday, February 16, 2007

I Left My Yen In Shinjuku

Rohan_888 said...
"Then, the yen starts to appreciate again – by a sharp 9% in one month - when a small emerging market economy defaults (Ecuador soon?) and a large hedge fund goes belly up (another Amaranth?). Then, suddenly one piece of good news comes out of Japan (a growth pickup?) and in a matter of 72 hours the yen appreciates by 12%. Then a major global macro hedge fund loses $2 billion dollars in 48 hours on the yen unraveling and decides to close shop; another one loses billions too and decides to restructure its operations. Carry trades unravel rapidly, margin calls are triggered, levered positions go belly up and the entire financial system goes into a seizure. Then the Fed is forced to cut the Fed Funds rate in between meetings by 75bps (in spite of still good US GDP growth) in order to avoid a financial meltdown, a collapse of US financial markets and a global recession.

Readers of this blog (Roubini) may think that the first paragraph above describes very precisely the current situation of the yen and of the global financial system in the last year. Indeed, news reports have been endlessly talking about the yen carry trades driven by low Japanese interest rates. Readers of this blog may also think that the second paragraph above is a typical Roubini "doom & gloom" fear mongering and describing a scenario that is totally unlikely to occur in 2007. But what I was describing in the first two paragraphs above is not 2006 and a fear mongering scenario for 2007 but rather what actually and exactly happened in August-October 1998."

My guess is that the current situation is worse than in 1998. Another worry seems to be realized at the moment, that the subprime lenders in the US are in much worse shape than most thought:
During 2007 more than 1 trillion ARM's will be reset, we only have just started.Economists from the Austrian school (Marc Faber, Richebacher, etc) expect a bloodbath in the US caused by overspending by consumers, rising debt on all levels and no "real" investments that cause growth, the only thing they have been good in lately is "asset shuffling" (hedge fund managers and companies like Goldman & Sachs) as Faber calls it. Almost all American economists however think that all will be well, because the US is so clever, surely they will find a way out. To me the Austrian camp looks a lot more convincing.

sopskysalat said...
One thing which you did not highlight Dali, that is, why not borrow yen and buy into nikkei directly instead of going for ADR in Nasdaq and Dow? I guess a lot of carry trades are going to other instruments than japan-linked. Nevertheless, today nikkei hit a new record. HSI and STI are taking a break.

Salvatore_Dali said...

To borrow in yen and then invest in equities is naturally a lot safer. The nature why the carry trade is so huge is that many prefer the double-whammy effect, but want to lock in the returns as well. So, to go short on yen, and going long on another currency maybe the only risk they want to take. To further boost returns, it could be an Aussie bond or Singapore REIT, ones with a fixed return somewhat plus currency gains.

To borrow in yen and go long in Nikkei is just a MARGIN STOCK ACCOUNT la... As usual the retail players are not that aggressive in Japan. As for institutions, that is akin to just being very leveraged, hard to explain to board of trustees.

sopskysalat said...

Alas, I phrased message wrongly. Sorry! I wanted to say borrow yen and buying into local Japanese stocks intead of going for ADRs. But you may have explained that to go for double whammy, one gain on FX and other stable cum high yield instrument. Perhaps, if the Japan equities are more attractive, then money will not be going elsewhere but Japan.

Salvatore_Dali said...

you are correct, if the investor was a Japanese investor, borrowing in yen to invest in Nikkei would be akin to Margin Financing, no big deal, happens all the time. For foreign investors, borrowing in yen and buying Nikkei stocks would actually be a very astute move (if they are as bullish as we are on Japanese stocks this year). Guess, some of them are not that bullish on Japanese stocks.

Of course the MAIN reason why they would not do that is that THEY EXPECT THE YEN TO WEAKEN, hence to invest in Japanese stocks on the Nikkei may see any gains being wiped out by yen's weakness - hence for a foreign investor, it is a difficult decision to go long on Japanese stocks in Tokyo. That is why I suggested Japanese ADRs as possibly the best instrument/investment this year.

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