Asia Centric by Bloomberg IntelligenceA rate hike from the Bank of Japan combined with weak US economic data coalesced to cause the biggest one-day sell off in stocks since 1987. What does this mean for monetary policy in Japan and the US? And how could investors position themselves for the uncertainty ahead?
Gareth Nicholson, Chief Investment Officer and Head of Managed Investments at Nomura International Wealth Management, joins co-hosts John Lee and Katia Dmitrieva on the Asia Centric podcast.
You're listening to Asia Centric from Bloomberg Intelligence, the podcast that pulls back the curtain on global business so you can invest better across the Asia Pacific rim. I'm John Lee in Hong Kong.
And I'm Katidmitriyeva also here in Hong Kong. The big event this month for markets, and really so far this year, was that one day mass sell off in stocks. A rate hike from the Bank of Japan and some negative economic data increasing the risk of resession in the US caused the unwind and panic took hold.
What does this mean for monetary policy for both Japan and the US and how should investors position themselves for the uncertainty ahead.
Here to discuss the fallout for financial markets is Gareth Nicholson, chief investment Officer and head of Managed Investments for Nomura International Wealth Management. Welcome to the show, Gareth, Hi, Thank you very much. Gareth. Before we dive into the details, can we flesh out for listeners what actually happened earlier this month? You know, what is the young carry trade and why did it lead to this market drop?
Yeah, it's been quite an eventful month, hasn't a kids? Yeah, but we should consider just before that, the month or even the six weeks before that, the market was incredibly stable. We had this almost paranoia being built into investors that we expect something to happen, but we don't know where, and they were watching and watching and watching, and after a while, stability builds kind of that paranoia, which we then saw with a slight surprise in the labor market data, I mean, the non von Perils expecting about two hundred thousand and they got one hundred and fourteen unemployment at you know, a little higher than what most expected. And then you tie that together with a little bit more hawkish bo j and we had absolute panic. And this panic, I think it's worth highlighting how almost crazy it was. In two thousand and one, you had three jumbo ray tykes just before the recession that was a fifty to fifteen fifty. During the Great Financial Crisis you had fifty and a twenty five in consecutive space. Now as of Monday, this is panic Monday. The market was pricing in somewhere between the two thousand and one recession and the GFC, so we were really as the market was expecting a huge slowdown, a hard landing, a serious recession and that just wasn't justified. And we've seen that comeback since we've seen labor market being not as bad, we've seen the inflation print come lower. You've also seen the boj take a step back in highlight. Yes we're hawkish, but we're not that hawkish. We're going to take our time to get to a terminal rate. So that was the main catalyst that kind of caused the shock, I think to your point, the second would be the carry trade.
What is the carry trade?
The carry trade, in essence, is the idea of lending from a country that has a lower interest rate, use that money to then invest in a country with a higher interest rate, maybe a higher growth profile, where you can pay off that loan that you got for cheap. Now, the move in the carry trade was exceptional and that was really highlighted. So that was a lot of foss money, a lot of hedge fund money involved in this, we believe, and if we look at the flow numbers that one of the most popular trades was lending yen, buying the dollar yen, investing that money into the growth tech Nasdaq. So a lot of hedge funds were borrowing cheap investing into high growth and making a very healthy return on their leverage position.
There.
When they started seeing that earnings weren't as strong as what the market had hoped for.
They were strong, but not acceptedly strong.
You saw the potential of a recession which will affect tech, and you saw that the prissing of their loan went up. They decided to cut this immediately, and we had about seventy five percent of the carry trade cut extremely quickly from extreme foss money, and that was also part of the panic. So that now is a lot more clean positions or a lot more normal and we can kind of move forward at a much more sustainable pace, Dorothy.
As you mentioned, we've somewhat recovered from the big sell off on August fifth. It was a reminder, however, of how things can go sout very quickly. Are we okay now? Do you think there's risks are hit?
John, That's a great question.
Very difficult to you know, predict the future volatility, particularly when you have warships, you know, moving up on the coast of around in Israel. You've got a lot of geopolitics happening in Russia and Ukraine. You have the election debates happening in the US in a few weeks time, plus the first time that central bankers will be really making a meaningful move, we believe in September, So we believe that the karm is with us for a few weeks. We believe September we'll see an escalation what we see a panic in the markets. I can't see a catalyst like the carry trade unwind at the moment, so we're keeping defensive, but we are investing in these dips. We do think it's an opportunity as our general case is that the central bank will react in a measured pace twenty five basis points, so definitely got to keep our eyes and ears open. We think it volatility will remain escalated, but there is no clear sign at the moment to particularly given the relatively strong numbers from the US, that will have another panic.
But never say never.
Could I ask you about that twenty five basis point cut that you have plugged in for the FED. The Philippine Central Bank governor said that they actually expect a fifty basis point cut, which is not what the markets expect. But I'm wondering could that potentially be a catalyst if we see something from the FED in September that kind of throws people off guard, or do you think that's kind of a distant possibility.
Well, I think when we talk about the FED, the real risk that we have is of a policy error, and this is about almost How's legacy. I think he's done a pretty good job at managing through COVID, through the inflation spot, through the tightening, now moving towards the loosening. Inflation seems to be on a disinflation environment, but there is uncertainty. The elections could bring the more inflation. Trade wars could bring more inflation, walk can bring more inflation. Does he want to use these big bazookahs immediately when there's still so much uncertainty and cut by fifty basis points and then have to reverse that if inflation comes. We think it makes more sense from his perspective to scale into it. The economy is slowing down, there are cracks, but by no means is it huge gaps.
I think he has.
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In that camp Garth, we believe it's going to be more of the soft landing than a recession. I mean, the indicators are a great way of highlighting warning signs. You know, inverted curve for a long period was another recession indicator, and then it was steepening up to the curve, which was another recession indicator. And there are all things to watch, but really retail sales. The people on the ground there still are sitting pretty flush, except for maybe the bottom tier where credit card delinquencies are increasing quite aggressively. A lot of people have made a lot of money on the stock market over the last few years. They're still sitting pretty okay. Mortgages have not affected them because the US has a large amount of the mortgages fixed, unlike places like Europe and Australia. So generally speaking that people on the ground have had a wage increases that have been relatively unaffected by at least by their mortgage payments, and they're doing all right. As I said, the crasis loans have formed, particularly in the more vulnerable part.
But often people forget that the economy is not the stock market. There is a difference.
Still, the economy could take a while first to see the crass stock market will be knee jerking both back and forth. But we think at the moment the stock market is going to focus on stronger retail numbers, labor markets that are not too bad inflation coming down and aren't going to be passing in any recession.
So how does that kind of inform your positioning right now? Like I'm curious, during the unwind on August fifth and then the subsequent bit of recovery, have you changed your positioning or investment outlook or pretty much stay the course.
So we felt that if we're talking equities, first off, equities have been quite expensive, and we've been thinking about this idea of well the next catalyst, and the cataists we were looking at the time was earnings. Will it be kind of fundamental foma when the earnings justify us breaking ever new highs, or will it be kind of a fomo trade where people will get a fear from an unnecessary number. It'll fall back and you'll need a new catalyst to get back in, so the new highs will take a longer time to reach, And we weren't certain to be honest, we were thinking, is much more of use the optionality, look at more call options, so you take a little bit of the money off the cards with regards to how well you've done this year. You buy the upside, you protect the downside. You're not going to get the full upside because there's a cost to that. But that was a better way and that's worked out relatively okay at the moment, particularly for the US markets and a few others for other high conviction trades where we've seen also a relative pullback. This has been a time for us to highlight to our clients to build up a position. Most people are long US, but there haven't been very long Japan and India. Those are trades which we've been suggesting buying the dips, and we still believe that they're quite convicted. So we're still of the camp that equity markets will do relatively well in a soft landing and a gradual fed policy. We think where we have shifted our trade is really pushing for our clients to move out of cash, out of deposits and invest that money. Push the duration out a bit for the safer, more conservative clients out to five to seven years. For some of the clients that want a bit more bang, really look at even the twenty plus, look to take advantage of the duration and the convexity there. But two different angles almost want this Bible approach of having some nice stable income that you were getting from deposits and securing that for a longer period, and then looking where you've got your highest conviction and using the strip that's slowly disappearing to add and rebalance.
If we could talk about Japan, you've got a feel for the Bank of Japan. They raised interest rates and it had led to this whole carnagean financial markets. Do you think this will in any way impact their ability to raise interest rates going forward?
I mean, I think its a great question right.
It was obviously a pretty big event, and I wouldn't say you're going to scare the BOJ, but it was definitely an eventful few days. I think what was telling was they did a summary of the BOJ meetings that they released after the panic, So we did the BOJ, you had they obviously the market reaction. Then you know, a day or so after that, they had pun to release the summary notes and what the final view was from the meeting, and they had the opportunity to downplay the hawkishness and downplay the idea of raising rates to the terminal rates of about one percent, but they didn't. They were pretty firm about the idea that they still want to get to that terminal rate. They still believe that there is enough economic growth inflation to support tightening policy two one percent, So we still believe they're in the right camp.
The BOJ is about the long.
Term picture, and they will react in the short term if there's too much volatility, particularly in the currency. But I think the way it's panned out, it's unlikely they're going to change their medium to long term actions.
So it sounds like you think that Japan is a pretty safe place, right now to invest and will be going forward. Can you tell me a bit more about that, sure.
I think Japan is a place that has been under invested for many years, for decades, so a lot of investors haven't really been involved in Japan at best. That's slightly underway to neutral when you look at international portfolio advice, and a lot of people are looking for excuses for Japan to go back to that very slow growth environment. But actually there's a number of catalysts which suggests this is just the beginning. One would be that the Tokyo Stocks Change are adamant about boarding this market up to a world class market with regards to corporate governance and making a conceited efforts to make sure that the corporates are aligning themselves with best practices going forward. You're seeing this in a number of things. You've seen this with share buyback programs, where the amount of money available, they're only spending argumbly sixty percent of it compared to the seventy percent, which is roughly where the average is across the globe seventeen to seventy five. The US is about one hundred, so there's a lot of room for further buybacks, and we know from an example in the US that that does propel the equity market. One of the other factors we think is very interesting is Japan's had this quirky nature of big corporates buying each other's stocks, propping each other's up, so cross holding of stocks. So you've got particularly the banks, huge explosion banks to other big corporates like Automobiles in Japan that managed just sitting there. They can do more with that many potentially capex and growth, and there is incentive for them to down play there, to sell those to invest it into more meaningful growth areas, and that has been one of the drivers.
That the Tokyo structure change is doing.
So we're seeing a lot of sectors looking to create more value within their corporates.
So that's the internal growth driver.
You know.
There's also a few macro ones as well.
And talking about Japan, is there any particular sectors or even themes that you like in the equity markets?
Well, yeah, yeah, I think so.
One of the themes that you know, from a contradictory perspective, which I think is worth highlighting right up front, is a lot of people think Japan exporter a stronger currency, the equities are going to struggle. But this is not one hundred percent accurate if you actually dive into.
The corporates you do, you know, bottom up, if you think about it.
After COVID, a lot of Japanese manufacturers move their manufacturing to other parts of Asia, you know, even more aggressive than we saw China do post the trade war conflicts. So a lot of the manufacturing is actually done outside of Japan, and the currency effect of a stronger yen does not really play out from an exporter perspective. Interesting though, one of the biggest headaches for these manufacturers in Japan machinery electronics is the idea of the commodity process being expensive because of the end. Now the yen is stronger, the material used to produce these are cheaper, and that's actually a nice tailwind. So manufacturing high machinery electronics we think that will be one of the sectors we like. The other sector on the back of the Bank of Japan increasing their interest rates would be banks. I think banks they do well in a rising rates environments. They're also, as you said, one of the sectors that are holding a lot of cross market stocks and are likely to sell those and use them for credits or for other lending capability. So the banks is another sector we like, and maybe the third one would be real estate. Now real estate is a little tricky because with interest rates rising, that tend to not be the place to go real estate. But from all the media to long term there is a lot of work that can be done from a corporate governance side in the real estate sectors in Japan. And you're actually seeing a lot of activist action happening, much more than we've seen over the last few years in this sector. So a lot of investors are recognizing the pent up value there in the real estate space and are looking to move there. And we shouldn't forget that terminal rates in Japan will likely be one percent. It hasn't been a one percent for many, many years, So the effect on the real estate is not going to be huge. It's not going to be going from you know, half a percent to five and a half percent as we saw it in the country.
You said that it's just the beginning for Japan's economy right now, where are we seeing signs of that in the economic data? For example inflation? You know this effect that the bank of Japan likes to talk about the virtuous cycle, you know, with higher wages, higher prices. Are we seeing that quite yet or is it still kind of early days.
I think the place that we're seeing this most would be actually in our retail site tomorrow is one of the biggest retail components of Japan. The amount of savings that's sitting on Japanese bank accounts, this is the mom and pops and the rest of US is now seven to eight trillion US dollars. This money is sat in bank accounts not having to worry about inflation, so they haven't really had to worry about investing too much. Prices haven't changed, so you just keep your money there and you sit. Isn't it now that's changing. The government is trying to stop this inertia. They are promoting tax incentives and initiatives to get more Japanese investing. The NISA, which is basically the trading account platform in Japan, has been growing phenomenally over the last six to twelve months, so there's a lot more accounts that are available to invest. The idea that these accounts now were investing in foreign stocks and local we're seeing a lot more truction now to the local stocks, and this is a fantastic sign for the long term. If you think of a place like India, India's market has been phenomenal because Indian buying India. Every time you get some sort of scare politics or em scare or the like, international money pulls out locals for that gap. When you start seeing that as a big mutual fund pension fund investor, that gives you this disability to say I'm going to do a structural shift and move from one two percent in Japan, for instance, and move up to four five percent. We shouldn't forget that MCI back in the eighties was forty five percent. Now it's like much much, much smaller tenth of that. So this is not an unseen circumstance that we can see Japan being you know, high single digits in some very big funds. So we think the flows locally and internationally are just going to recognize Japan as a long term growth story and that's grateful for the markets and also for the economy.
Gas We talked a lot about the equities, but I know you look at multi assets. What's your views outside of equities, Like, what do you think of in terms of fixed income FX credit.
Yeah, so I think that you know, for any balance mandate, we need to be focusing on inc. It's really been an equity story for the last five to seven years, maybe even a little bit more. But now it's going to shift much more to a balance approach of having that stable income. That SEVIL income is going to come from largely duration at the moment, as credit spreads still remain tight. As I say that, you're seeing credit spreads widen CDs and some high yield so there is a lot of interesting specialists that can help manage the widening credit spreads and lock in some interesting returns by taking credit, so you wind the rates exposure. As I said, we like the five to seven year part for stable money. We see tactical opportunities in the twenty plus. We're resigned to see credit becoming more of an opportunity, albeit we want to be selected there because we think credit is going to widen from here in the short term.
So that's interesting.
Some of those opportunities in credits will exist in the private markets as well. We think private credit is an interesting space to lock in high returns where the credit woes for private credits really gets down to the legal specialists who can manage the covenants and the understanding of the deals and really work there through. So there's some fantastic names of big brands that just focus on private credits and we think they're forming an integral part now of balance mandate. We have up to twenty five percent in alternatives, and private markets make a large part of that.
Gareth, is there anything else that you wanted to cover? You know, let's think about some themes that you're looking at.
Well, one of the thematics that has become as staple is AI, and it will still remain front and center. But I think when we look at building resilience, enhancing yield and portfolios, which is going to become more important because you're not getting five percent cash and your tech just continues to surge upwards, it's going to be much more active management. We need to find places that we can haance the performance with something that's got a tailwind. Now AI big company AIS they're going to remain robust because they're basically control the entire chain of AI development and tech. But some of the specific sectors we see a lot of interest at the moment and we're spending a lot of time looking at the matics actively and rotating from one to the other as the theme kind of progresses. We're seeing a lot of traction where the AI is trying to give the robots, the devices, the electronic manufacturing machines a bit more brains, and these are tarting to play out in things like healthcare where we're seeing a lot more development so quicker. You're seeing wearables becoming much more useful and integrated, and so we think healthcare biotech is a space that has had a bit of a hangover after COVID.
And is now coming back.
We're seeing communication, particularly from a space perspective, communication from a defense and aerospace as an area that is getting a lot more focus. And again the way of combining a bit more intelligence with the existing infrastructure is great. And finally, around infrastructure, one of the themes we think is important is most countries realize, now they don't have access to energy, they're going to remain a poor country. Rich countries realize they have to make maintain their growth of access to energy. So energy infrastructure is going to remain particularly key given it might take longer to move fully onto renewables. They have to be able to cater for coal, for nuclear, for renewables and all the like. So we think the plumbing around energy is going to be a very interesting theme for the next few quarters.
Yeah. I remember reporting a story last year in Fargo, North Dakota, of all places, and they were opening up in the next few years as AI command center for their hospital, and it was taking tens of millions of dollars of investment. But it sounds like that's the kind of area that you're interested in and that you're thinking about when it comes to AI and thematics.
I don't know that you're I mean, Singapore's a very different story. But you travel to some countries and you're unfortunate to go to the hospitals and the way it feels like it is extremely slow and maybe there's a chisel and a piece of rock in the background somewhere. There is a lot of improvements that could be had in many healthcare systems, and I think this may be some of.
The technology to enable that.
And then you tie that into the incredibly complex parts of biotech, where they've proven that artificial intelligence and the use of mathematic models does add a big advantage.
But it's surprising because it seems like your view on AI hasn't really shifted that much, or maybe it has since that big stock drop, because that was one of the stories, right those you know investors maybe kind of souring on the AI growth story. Has your view changed it all in the past couple.
Of weeks, O've used just become a little bit more nuanced. For us, AI is the refrigerator. It's, you know, fantastic technology refrigerator built back in the fourties fifties, great, very.
Useful to a point people loved it.
Yet the real money was made when Coca Cola started us their refrigerators and sold their product globally all over the place. So we're looking at the Coca Colas which are looking to use AI and expand that through. So the first wave was the refrigerator. I think that that's largely been done. Now we're the rights of the big names because they have already started investing in Coca Cola equivalent. But we're looking for those sectors which are going to be the next Coca Cola of the fifties sixties.
Have you used that in a note before that? Analogy that was.
Our basically our theme for the beginning of the year.
We thought that the mag seven was going to sore feeling pressure ready from January, but it showed us wrong that they continue to do well for quite a large part of the year. But at the same time, the Coca cola trade has also done well, and that's actually held up pretty well even in this panic.
Monday, Gareff, I wanted to ask you, look, you obviously work for a famous Japanese company. We've spoke a lot about Japan. It sounds like you're a japan expert. What do global investors often get wrong about Japan?
Well, To be honest, I think global vessels have had the rights to not look at Japan as closer as they've needed to in the past. It hasn't been an asset class that has done very well for the last five to ten years. So I think that is what's happened, is they don't have the same sort of research, they don't have the same sort of focus. And I know the very big names, and they probably only know those names at the moment. Now they're realizing that you've built up a huge overweight to us, you want to maybe diversify that into other developed markets. You may have had some diversification in China, but you feel like that growth story still has some up your battle and they're saying, Okay, I need to get in Japan. How do you understand Japan? And it is a lot of research in Japanese. It is a market that is you don't have super champions like the mag seven. It's distributed across many companies, so it really just requires.
The deep dive.
And I think we were seeing a lot of investors doing that deep dive now, which is fantastic, and they're coming from a low base. You know, for many many years when I worked in London, global portfolios are less than two percent in Japan. Now that is I think an incorrect use of asset allocation. Really you should be a lot higher than that if you want to build resilience in a portfolio where you could have a US recession or at LISA slowdown in performance from a very strong run.
It's been an interesting conversation on Japan, n carry trade, central bank policy, and the state of the financial markets. Thank you Gareth for coming on the podcast Leisure.
Thank you very much for having me.
I'm John Lee in Hong Kong and I'm Kadjidmitrieva, also in Hong Kong.
And this podcast was produced by Clara Chen. And you've been listening to the Asia Centric podcast
