The market is blowing up this morning and the question is, why? The answer is the same as always: Reckless speculators borrowed too much money against the wrong asset. Will they ever learn?
This time it is the yen carry trade. In plain English that means some speculators have borrowed money against the yen because Japan has some of the lowest interest rates in the world. They then use the money to speculate in stocks, which increases their returns dramatically, right up until the moment when it blows up and they lose everything.
Long-term readers will recall we wrote about this in 2008. At that moment it was mortgage-backed securities. It was the same in that massive borrowing led to the eventual collapse. That was more important because the asset people were borrowing against, mortgages, were more central to our economy and the speculators were big banks.
This appears to be more similar to the late 1990s when a hedge fund ironically named Long-Term Capital Management got over its skis with rubles (Russian currency). I lived through that one as well, but it was before we started Iron Capital. Long-Term Capital famously was staffed with a bunch of PhDs, who were living proof that there is zero correlation between intelligence and wisdom.
In that crisis we went through a short period of extreme volatility and then the market came roaring back. There are no guarantees in life, but I suspect the same thing will happen here. This has nothing to do with the real economy, which is still fine at this moment. Nothing in the real world has changed since we sent out last week’s Insight.
Periods like this are not fun, but for prudent investors they do create opportunities. We need to give this some time, but as the old saying goes, we want to be greedy when others are fearful, and fearful when others are greedy. In the meantime, we will do what we can to mitigate short-term damage. The most important thing is to remember that panic is never a wise strategy.
Warm regards,
Chuck Osborne, CFA
Managing Director
