Magic Markets #220: The Global Asset Ownership Web

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The Finance Ghost: Welcome to episode 220 of Magic Markets. We are starting to head into those holiday weeks now in South Africa after a very hectic Q1. Thank you for listening to this. Whether you’re listening to this on your holiday, on your way to your holiday, running at the gym, in the car, whatever it is you’re doing, thank you for making us part of your life and your market research. And today will be another interesting chat, I think, Moe, where I know you want to focus on the foreign influence on American assets, essentially. I think that’s going to be really interesting.

I know you don’t want to talk about your intraday trading strategy, which I can only assume is because it has been less than optimal in some of these tough days. I, on the other hand, just haven’t looked at any of those dips that I bought last week because I bought them for much longer than a week. So that’s the benefit of not doing the intraday stuff, is it’s a buy and forget.

But I was right about Rory winning at the Masters, so maybe my Acushnet position will come right? Because the number of people talking about golf and having watched the golf on the weekend, it’s actually quite extraordinary. I joke, but there is some method to that madness. As we head into the summer seasons, I do wonder if you’ll see some new golf clubs getting bought. I certainly hope so as an Acushnet shareholder.

 

Mohammed Nalla: Yeah, Ghost, heading into the summer season up here in the northern hemisphere actually is fantastic because we’ve got a lot of great golf courses. I’m not a golfer, right, I know you’re a golfer and again, you’ve got to understand the sport. But it has been gathering a lot of momentum. You pointed me towards a Netflix equivalent of Drive to Survive, but in golf. I haven’t watched it yet. I’ve got to convince my wife to watch that with me. Golf, in my view, a lot less exciting than Formula One. But it’s maybe park that, I’m going to watch that Acushnet position that you took because it might take some time to germinate. Let’s see what happens over the next quarter or two. If golf is actually growing on a structural basis, that does bode well for a stock like a Acushnet.

I’ll touch on my intraday trading as well. I don’t want to go into a lot of detail around this, but last week we touched on this, and that was prior to what was one of the largest intraday moves that we’ve seen in history, right? We had the Trump tariffs-on, tariffs-off, like Karate Kid, tariffs-on, tariffs-off. We had that and it was a move of over 9% on the day in the S&P, around 14% on the Nasdaq. That’s just epic and I guess less than ideal situations to be experimenting with an intraday trading strategy.

So on that day, yes, I took some losses. Certainly not like, you know, oh, it’s just a flesh wound and my arm’s missing, but it doesn’t help to take losses. Certainly refining that within what we’ve seen globally because it is also an unprecedented time. If you look at something like the Economic Uncertainty Index, I’ve actually just done a quarterly report for a client, and that Economic Uncertainty Index, you can go and pull that up on TradingView, whatever it is, and go and have a look at that. It’s at levels north of where we were in the pandemic. It’s unprecedented. We’ve never had this level of economic uncertainty coming out of the US, ever.

And I say that not very lightly. If you look at it globally, it’s probably tracking on levels that we had seen in other crises. And yet no one’s actually issuing that word as part of their framework. They’re not saying we’re in a crisis, right? People are saying, oh, it’s a correction within a bull market. I think the jury is out on that. I don’t subscribe to those narratives of, hey, you’re down 20% and now you’re in a bear market. I think those are too simplistic. But I think we’re seeing some structural changes in in terms of how the US operates globally, what that means for the global economy and then what that means for capital markets and asset prices.

And so that feeds very nicely into what I want to talk about this week, which is the fact that you’ve actually seen over the course of the last several weeks – yes, lots of volatility in US equity markets – but a lot of people are not paying attention to what’s been happening on the US Treasury market. And that’s because a lot of people, retail investors, don’t look at bonds. But it’s so important because if you look at the US 10-year, for example, you’ve got to use that as your de facto risk-free rate. We can get into whether that’s actually the risk-free rate. Is the US still the safe haven it was before?

But you’ve got to look at that. And when you’re looking at that US 10-year, it actually moved a little bit lower as inflation started coming down. And people thought, hey, guess what, the Fed’s going to have to cut interest rates. And then all of a sudden tariffs were thrown on the table. And this upsets the overall architecture simply because tariffs actually have an inflationary impact. And so if inflation’s gonna be stickier, if it’s actually gonna trend a little bit higher than the Fed previously expected, this actually mitigates the potential for deeper cuts from the Fed.

So that came through in terms of US yields actually being range bound, slightly higher than they were. And then interestingly enough, we actually saw over the course of the last two weeks, massive pressure on the US 10-year. And there’s been a lot of chatter on social media saying, is this the Chinese? Are the Chinese weaponising their $1.5 trillion worth of US treasury holdings? They’ve got that in reserve, right? Are the Chinese weaponising that?

Because the US has significant refinancing risk this year, they’ve got to refinance a lot of that debt as it matures and they’re going to want to roll that. So if you can keep the pressure on that US yield curve, it means the US is going to have to refinance at much higher rates. That lends some sort of support to a narrative that, hey, the Chinese – well, guess what, I don’t think it’s the Chinese, Ghost. I think it’s actually the Japanese yen carry trade that’s actually been one of the driving factors. And we can unpack some of that as we go into the nuts and bolts of what’s actually happening behind the scenes.

 

The Finance Ghost: Yeah, look, I think let’s go straight into that because this is obviously quite complicated stuff. The world is very interconnected. Countries are trading with each other, they hold debt in each other and one another. But there’s also lots of hedge funds out there doing all sorts of trades and large institutions. And now this is the reality, is that none of this stuff is isolated. It is ultimately all connected and it drives activity. We just saw the banks release earnings – JPMorgan, Goldman Sachs. I was pretty stoked to see that both of them on the equities trading side did really, really well. It’s kind of a natural hedge in there that when investment banking fees are down a bit, they do really well on the trading side. Market volatility, not necessarily the worst thing for them. This is the reality of capital flows and free markets is you get stuff like this carry trade. I think we have talked about carry trades before a little bit on Magic Markets, but it’s well worth recapping it. When you talk about that yen carry trade and the effect it’s having, what does that actually look like? What are the mechanics of that?

 

Mohammed Nalla: I think that’s a great place to start. But before I’m going to jump into just explaining the yen carry trade and why we’re talking about it, you’ve actually raised another important point which I just want to touch on, because that’s not really the thrust of what we’re discussing today. But you’ve indicated how there are lots of different players in the market and you mentioned hedge funds and that’s an important one because if you look at traditional asset managers, pension funds, they tend to take a long position in fixed income instruments. They’ve got to hedge long term liabilities. But when you look at hedge funds, they actually play on the differential between treasury futures and what’s actually happening on the bond market. So it’s the physical bond versus the treasury future.

Now, those actually have a slight differential in pricing and it’s referred to as the basis trade. I’m not going to go into the detail, that’s probably a subject for another day. But a lot of people out there saying that some of the unwind, some of the pressure you’re seeing on US yields is the unwinding of the basis trade as hedge funds look to actually delever their positions and get out of some of that. So that is one of the factors. I’m not saying that the pressure is definitely the yen carry trade. There are a lot of factors at play. Go and look at the basis trade as well. If that’s unwinding, that potentially could also be a source of pressure.

But let’s jump into the carry trade, because the reason I like this one is that it actually has relevance to South African investors. I know a lot of our listeners are predominantly South African. South Africa has the benefit of being a high yielding destination. Our fixed income markets, if you look at it on a risk-adjusted basis, have actually delivered superior returns to South African equities over I would say the last two years. If you look at what you’ve been able to get in the bond market, the All-Bond or whatever you choose to play in. on a risk-adjusted basis, the returns have been superior. Now, if you actually zoom out and you look at that from the position of an international investor, international investors look for jurisdictions where they can actually extract a good real yield. The real yield is the difference between what you’re getting on the bond in terms of your yield, versus inflation. With South African inflation being reasonably well controlled – not a popular view, people don’t like the SARB for this. They say they’re running monetary policy too tightly. But guess what that actually does? It protects your yield differential against other global destinations and so by extension actually helps the Rand which then by extension helps South African inflation. I certainly think the SARB’s doing a fantastic job around this and I know that’s not going to win me any friends amongst our South African listeners that would like to see rates a lot lower, but I see the method to the madness.

Now let’s rewind to the yen carry trade. Japan historically has been an origination destination for that carry trade and the reason for this is that Japanese yields are very low. Japan had gone through a decade or two of deflation, really painful times in Japan. They ran policy very, very easy. They actually move into negative rates before a lot of other major central banks when we had crises. As a result, the yield on Japanese 10-year paper for example was close to 0%. For the longest time you earned nothing on your Japanese investments. So what investors would do is they would originate loans in the Japanese market, they would take that money out of Japan and they would invest that in global destinations. I’ve mentioned South Africa as a high yield destination, but a lot of that also flowed into the United States. Because if you can actually go and raise money in Japan at zero and you’re investing in the US at let’s say 3%, that’s a lot lower than where we are now at 4% on the US 10-year. If you can go and invest it at 3%, you’re actually extracting that yield on a fairly low-risk basis for as long as the currency doesn’t move against you.

Now that is a big “for as long as the currency doesn’t move against you” because if you go and have a look at what’s happened, given the recent tantrums we’ve seen around tariffs, the uncertainty around the US, you’ve actually seen the Japanese yen start to strengthen. Now this is bad news if you are a carry trade investor because it means your investments in the US are going to have to be repaid against your loans in Japan that are getting a lot more expensive. For context, if you look at the Japanese yen versus the US dollar, it peaked last year around 160 yen to the US dollar. It then trended lower to around 130. Then it bounced back up again. And then this year, just this year, it’s moved from around 160 yen down to where we are right now, around 136, 140 yen there and thereabouts. That strength has started to actually hurt.

And as it hurts, you start to see investors unwinding those investments in the destination countries and reversing that, repaying their loans in Japan. Now, it’s not just the fact that the yen has moved, it’s also the fact that if you go and have a look at Japanese rates, I indicated how those were around zero for the longest time back in 2022. Literally zero. Now it pushed up to a high of around 1.6%. Doesn’t sound like a lot, but guess what, when you’ve got that cost going up and you’ve got US yields coming down happening around the same time, it starts to catalyse an unwinding of this carry trade because you’re feeling pressure on your funding leg, you’re feeling pressure on your investment leg and you’re feeling pressure on your currency leg.

It actually got, as I indicated, got to around 1.6%. That was the high this year, went down to around 1.1% and then blipped back up again around 1.3%. Seems like it’s at the margin. What I’m watching is: what is the spread between Japanese 10-year and US 10-year? That’s kind of averaging around 3%. So not panic stations yet, but it did go as low as 2.2%. At those kind of levels, it’s just not looking compelling anymore.

You’ve also, last point Ghost and then I’ll pause, is you’ve got to look at the relative performance on equity markets. A point I’m going to touch on as a follow-up is also what extent of US Capital markets are owned by foreigners. I’m going to save that for a little bit later. But Just looking at the moves on the Nikkei, that’s down around 14%. Given the volatility we’ve seen in markets versus the S&P, that’s down 23%, these are year-to-date kind of numbers, you’re seeing pressure on equity markets as a destination investment, you’re seeing pressure on bond markets, you’re seeing pressure on the currency.

And the last point I’ll just stop on this one, is the US dollar still the safe haven of choice? If you look at currency performance, the dollar index has actually weakened quite a bit this year. And which currencies have actually done well? Well, the rand’s kind of held its own, but it’s not really where you want to be. Go look at the euro because if you look in the dollar index, you’ve got to look at the euro, that’s a very large portion of it. You’ve got to look at the yen, those have also trended stronger. And then one that not a lot of people look at, go and look at the Swiss franc, that’s also trended stronger against the US dollar. This tells me that international investors are starting to reconceptualise how they consider safe havens. The dollar not looking that safe right now.

 

The Finance Ghost: So Moe, you’ve touched on some really interesting and complicated trades there and we certainly invite our listeners to maybe rewind and just listen to it again because it is quite complex stuff. Sometimes we do easy stuff, sometimes we do hard stuff on Magic Markets. But the one thing that is supposedly an easy rule of thumb if you go all the way back is the sort of 60:40 split of equities and bonds. I’ve been reading quite a bit recently about how that’s really broken down because of correlation, or there’s arguments being made that it’s broken down because actually bonds and equities are more correlated. What are your views on that and how do these international ownership percentages of bonds actually affect that viewpoint? Do people really need to rethink that rule of thumb or do you think it is actually still applicable?

 

Mohammed Nalla: I think it’s a fantastic question. Let’s unpack it because it’s going to differ based on which markets you’re looking at. So in South Africa, like I say, over the last two years, bonds have been a fantastic diversifier. If you were actually running that portfolio in South Africa and you actually had some bond exposure, that probably would have done you well in terms of diversification. But also remember that South African equities behave very differently to some of the global equities. You’ve got a different economic cycle going on down there.

So when you look at global 60:40 portfolios, and again, for those of you not familiar, the traditional mantra is in a long-term retirement style portfolio, in fact, South African regulations still kind of subscribe to this, right, Ghost, you’ve got 60% equities, you’ve got 40% bonds. That’s a very simplistic breakdown. It does get a little bit more sophisticated, but for simplicity, you’ve got 60 in equities, you’ve got 40 in bonds. And this theoretically, because of the uncorrelated nature of those two assets, should give you good diversification through economic cycles.

Now I say simplistically because if you look at – let’s look at the US market because that’s the world’s largest market, right? If you look at a rolling one-year correlation, because again, investors make these decisions on a tactical basis, even if you’re in it for 10, 15, 30 years, you’re going to look at the rolling one-year correlation to determine, am I supposed to be heavier in bonds, am I supposed to be heavy in equities? And tactically move your portfolio around, that’s what asset managers do. I’m going to say it depends on what your overarching macroeconomic regime is, because if you look at this from the 1970s, and I use the 1970s because that’s when the world went off the gold standard and a whole bunch of things changed. There was a structural shift from the 1970s all the way through to I would say the late 1990s. You actually had a positive rolling correlation between stocks and bonds. That’s because you had US rates trending significantly lower. Remember you had the Volcker years and then rates trended lower. You went into a structural low-rate environment and lower rates means it’s better for bonds. Remember, bond prices actually move in the opposite direction to bond yields.

Now bonds were going up, it was a great time for bonds, but equities were also largely over that time period going up. And I say this, really everything went up against a debasement of money. Again, subject for another day. Then from the early 2000s, remember we had a lot of crises – the emerging market debt crisis, then we had the dot com crisis, then we just got through that and we had the global financial crisis in 08. So, from the early 2000s, think dot com crisis, you actually had that correlation flipping into the negative space. So then, you had a good diversification between bonds versus equities. Including bonds in your portfolio actually enhanced your diversification.

And that’s really been the theme all the way up until, guess what, the pandemic. Because in the pandemic, bonds went all the way to the moon because yields fell through the floor and yet equity prices shooting to the moon as well. So that correlation has flipped positive again. For me, we need to see what the current economic regime means, the reason for the breakdown in the 60:40 relationship and why that is actually broken down. It’s not really giving you great diversification, actually because you’ve seen that correlation flip into positive territory again.

Now Ghost, I’m going to move from that into my last point that I want to land on for this week, and that is with regards to your question around foreign involvement in US capital markets. What does that look like? Because we talked about the yen carry trade, we’ve talked about how US bonds have actually sold off a little bit in the cycle, as have equities. Talking to that positive correlation, remember positively correlated means that they move in the same direction. And some of the reason for this is if you look at foreign holdings by asset class, you’d think the foreign holdings of US Treasuries have the larger share, right? We know that China has a whole bunch of US Treasuries. We know Japan has a whole bunch of US Treasuries.

Guess who has a whole bunch of US Treasuries? The US! the Fed has a whole bunch of US Treasuries. US pension funds have a whole bunch of US Treasuries. So when you look at it as a percentage, then you’re sitting down at levels of around 30% – 30% of US Treasuries are owned by foreigners.

Now, that seems like a lot. But if we actually look at the quantum, if we look at it in terms of trillions of dollars, it translates to around $7 trillion, which is why you’ve got to look at equities, because the equity market is actually massive. Here you’ve got around $18 trillion that is actually owned by foreigners. Now, it’s only 20% of the total equity market. But those numbers are both very big because it’s 20% of equities, it’s 30% of treasuries that are out there in terms of the open market. And then if you actually extend that to things like corporate credit, it’s around 30% as well. So that’s the fixed income versus equity exposure.

The reason why I raised this is that if we actually see that carry trade unwind accelerating, it’s not just Japan, it’s going to be China as well, it’s going to be Europe. And so the question is, has the world lost trust in the United States? That’s really the question for me that will structurally define the era that we go into over the course of the next four years. And can that damage actually be reversed? Because I would argue that trust is lost. The US has lashed out against some of the biggest trading partners and allies, Canada being one of those. And if that trust is lost, you don’t have to see the entire position unwind. It doesn’t have to go from 30% to zero, but if it goes from 30% to 20%, that’s still trillions of dollars. If it goes from 20% in the equity market down to 15%, that’s trillions and trillions of dollars. Just keep an eye on that as a structural issue and a headwind. We haven’t quite landed on where it goes, but those are some of the risks that I’m watching on the macro framework, Ghost.

 

The Finance Ghost: Yeah, lots and lots of macro stuff going on. I guess just one comment before we sign off this week – I’ve seen an interesting uptick in some capital allocation decisions in the property sector. So obviously you’ve gotta be careful to say, oh, this is indicative of the whole market. It’s not that – these are just examples – but I think what it tells you is that it is a very good time to be sitting on a strong balance sheet. We did Berkshire Hathaway a couple of weeks ago in Magic Markets Premium. You’re not going to get a stronger balance sheet than that. I saw an absolutely bonkers post on X today. I wish I’d actually saved it. But it was something to the effect of Berkshire’s cash pile can buy something like 440 companies of the S&P 500…

 

Mohammed Nalla: …It’s wrong!

 

The Finance Ghost: Oh is it wrong? Is it nonsense?

 

Mohammed Nalla: It’s wrong. Yeah, I saw that and I was like, Berkshire’s cash pile is really big…

 

The Finance Ghost: …it struck me as insane. It seemed nuts. Okay, so that’s nonsense.

 

Mohammed Nalla: But guess what? The US market’s really big as well, right? So I think someone missed a decimal on that one. It is nonsense, but it doesn’t detract from the fact that Berkshire is a monster. They’re sitting on a monster cash pile. And you know what, Ghost? The more important question here is, does Berkshire choose to deploy that balance sheet buying up US companies or do they do what they tell us they’re doing? Guess what? They’re buying, Ghost. They’re buying Japanese! They’re buying Japanese companies. So this plays so nicely into what we’ve just spoken about here. Berkshire looking to Japan, they’re looking to China. It’s a big cash pile. It’s just not quite that big.

 

The Finance Ghost: Yeah, when you see ETF providers putting out ads like buy the market, it means something different to Warren Buffett! He really can just buy the market. I’m actually kind of glad that it’s nonsense. I saw it and I thought, geez, that doesn’t seem right. But I’m glad I raised it here because my alarm bells were ringing somewhat. Anyway, they do have a ton of cash and it’ll be interesting to see what they do with it.

But property as well – we’ve seen some interesting capital deployments. Vukile has done a deal for a Portuguese property, looking for growth in Europe as opposed to going into your slower-growth, supposedly safe havens in Europe. I’m not sure there are any safe havens at all, really.

Evidence of why you need a strong balance sheet – you’ve got Gemfields now having to do a rights offer here in South Africa because they have simply – they really did take a big risk on their capex programme at a time when the market for emeralds and rubies is not good. And it turns out they ran their balance sheet too hot and now they need a rights offer.

It’s just interesting to see, and this is what you’ll see as the market gets harder, is strong balance sheets will do really well. Marginal balance sheets will struggle. Weak balance sheets will either end in rights offers or being takeover targets for strong balance sheets or whatever the case may be. That’s how it works, those who created a strong business going into the hard times will emerge much stronger. I think it’s something to just keep in mind when you consider if you are buying any dips, as the saying goes. Maybe just think carefully about the difference between companies that are in a turnaround that just got a whole lot harder now versus companies that the market is saying we’re a bit nervous, but actually the company is fine. Identifying the difference there is what buying the dip is all about, really.

 

Mohammed Nalla: Yeah, Ghost, maybe to wrap up, I think the Gemfields reference here is so interesting because I just saw some commentary coming out of LVMH – you’re talking strong balance sheets, you’re talking good exposure to the richest people in the world, even LVMH saying that they’re starting to see some strain in terms of certain luxury segments that they operate in. So just pay attention because there are big structural trends underway here.

I think if you weave together what we’ve discussed on the show over the course of the past several weeks. We’ve discussed defensiveness, we’ve discussed different sectors, now we’ve discussed different asset classes. It’s really just aimed towards educating yourself. It is a big market out there. It’s not just beyond South Africa, but it’s also beyond just looking at the equity market. You’ve got to look at bonds, you’ve got to look at currencies. And we hope that this helps build out your overall investment knowledge.

Unfortunately, that’s where we’ve got to leave it this week. Let us know what you thought of the show. Hit us up on social media. It’s @MagicMarketsPod, @FinanceGhost and @MohammedNalla, all on X. Or go and find us on LinkedIn. Pop us a note on there. Until next week, same time, same place. Thanks and cheers.

 

The Finance Ghost: Ciao.

 

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