Markets resume previously scheduled exuberance

0:06Pushkin. You know that feeling when you turn your back for 10 minutes and all hell breaks loose. Well, that. I went on holiday, very nice it was too, and the markets went loopy. Adding to the loopiness, they're pretty much back to where they started. How on earth does that all make sense? Today on the show, keep up at the back, the market mini-crash is old news. We're going to talk about why markets have recovered and what it all means. This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist at FT Towers here in London, and I'm happy to say I'm joined by the estimable and finely dressed Rob Armstrong.

0:49Rob, I have decided for one week only to be nice to you, not least because you're out of the studio this week, so you've got a slightly wobbly internet connection. Where on earth are you? I have been drawn out to eastern Long Island by family business, and so it appears they've just discovered the internet out here. And if it sounds like I'm talking to you through two cans and a piece of string, that is why. Now, have you gone out there because you're hiding from the markets turmoil and you decided to buy tinned food and guns? I just couldn't take the pressure anymore, Katie. What did you do to the markets while I was away?

1:30I mean, it all went wrong. I think the basic story is familiar right now. The markets fall in the United States on a Friday. On the Monday, Japan's market starts freaking out. Everyone starts saying the phrase carry trade, carry trade, carry trade again and again. And then the whole situation starts feeding on itself. And global markets fall whenever they fell 6 % in very short order and now have bounced back. But I think what readers might be wondering, Katie, is that given that this was now a couple of weeks ago, why are we still talking about this? Six percent between friends. We bounce back.

2:13We're back where we were. What's of interest here? I mean, you know, since I got back from my holes, it's still the number one topic of conversation in markets. You know, everyone's kind of looking around, you know, investors and analysts at banks or whatever and are basically saying, what the hell just happened? Does this tell us something about how robust markets really are? They've kind of stock markets have been just one way traffic higher for the longest time. And these little episodes make you think, hang on a minute, are we is this all just built on sand? Are we just like hurtling towards a disaster?

2:48I think that's correct. I'm looking here at some data about the S &P 500. And half of the total gains in this bull market, this is a much quoted stat, but it remains true. Half of the total gains in this bull market, which started back last October, are from 10 stocks. So there's like a small number of stocks powering a huge rally. You know, the market is up more than a third, you know, over the last year. You have a few stocks that are doing it. And what's powering those stocks up is not just earnings. It's expansion of valuations. About half the gains are down to increases in valuation rather than increases in earnings or earnings expectations.

3:33So you have a highly concentrated valuation-driven rally that's gone on for a long time now. And what happened a few weeks ago makes you think maybe this is all a little spooky. It makes you think, hmm, can you spell bubble? Yeah, exactly. Yeah, there's three B's in that as far as I know. It feels bubbly. Yes. But so one thing that I think is interesting and that you were writing about in your newsletter today is that we've had a bounce back, right? So the bond market is slightly doing its own thing. Perhaps we'll come on to that in a little while. But stocks are pretty much back where they started.

4:11So you had, for example, like, you know, one day again, while I was sitting on my sun lounger, enjoying myself, not thinking about markets, Japanese stocks fell 12 % in a day. That is a lot. But they, you know, they've got their boots back on. Other markets are pretty much back to where they started. Now, is this actually a recovery or does the flavor of bounce back not quite match the flavor of the drop, if you see what I mean? Yeah, so looking at risk assets in the United States, the S &P 500 is now higher than it was a month ago. Spreads over treasuries of U.S. corporate bonds are back to the incredibly tight levels that they were a month ago.

4:59For non-spread specialists, that's a good thing, right, in terms of it means that the valuations have come back up on those. Yeah, when spreads are tight means for taking risk of default in a corporate bond, you're earning less money over what you would earn having a riskless treasury. So a tight spread means that's the equivalent of expensive stocks, except for bonds. However, looking over the course of this crash, actually the stocks that have performed the best from before the whole crash started until now are actually defensive stocks. So utilities, consumer staples, health care, going back to the beginning of the month or the end of July, those are the stocks that have done best.

5:45So, yes, we are continuing to rally. U.S. stocks continue to be expensive and as a group go up. But it is interesting that the stocks that are going up the most are the ones you'd buy if you were a little bit frightened. Healthcare companies, companies that make like peanut butter and cigarettes. Hopefully that's not the same company. And then, you know, utilities, things where demand is steady in all economic conditions. You can't get much more stapely than cigarettes and peanut butter. These are two of the main food groups. So there is this whiff out there of risk aversion. It's not strong enough to actually make people sell, but there's this mild shifting of the internal composition of the market that suggests that the crash of early August had a sobering effect.

6:40I agree with you. The bounce back is not exactly, you know, hey, let's go back to the party. and one thing that strikes me is that I just feel like investors were looking for an excuse to like bake in the amazing returns they've had so far this year and just take a little bit of a pause and one of the reasons I say that is that you know everyone's pointing to oh it's the unwind of the yen carry trade that's behind this this drop in US stocks so for the uninitiated this effectively means you've got super super low interest rates in Japan you've got a very very weak yen. The idea is that there's lots of bets that are effectively funded in very cheap yen that are pouring into US stocks and that this is one of the reasons why US stocks have been supported.

7:24And therefore, when you start to see that unwind because the yen has suddenly popped higher, this is one of the reasons for the US stock market to fall back again. Now, one of the problems I have with that analysis is that, OK, sure, there are definitely some Japanese investors who have been using their very cheap yen and putting them to work in a super sore away US stock market. But I feel like it's kind of cheating to say, well, as this unwinds, this pulls the US market down when the grand sum total of humans who ever said to me that the yen carry trade was a reason for the market to go up before this happened was zero.

8:03Literally nobody mentioned this. I think that's right. As I might have mentioned on the show before, you can never overestimate the desire of people in finance to want to say phrases that make them sound sophisticated. And one of those phrases is carry trade. And it's also convenient to have a two-word explanation for a situation that you don't really understand. So I think that part of it was probably over-egged. And in fact, I think maybe the recession worry aspect of this was probably over-egged too. And your comments before got into this, maybe we have not emphasized enough the importance of having a very crowded set of trades.

8:52Everybody was on one side of the boat. There was a little wobble and everybody ran to the other side of the boat. It wasn't that they really thought there was going to be a recession in the United States or that the estimate of the probability of a recession changed so much, it was, oh, whoa, whoa, whoa, whoa, wait a second, wait a second, because we'd all gone a little bit too far into one set of trading positions. I'm sure the bond market used to be a bit more grown up than this. Like, it's much more flighty, it's much more prone to overreacting to individual bits of data than it used to be.

9:27But yeah, that has ripple effects across the whole market. I will say in defense of carry trade talk, there is a pretty clever guy who I spoke to recently who's a professor at the University of California, Kevin Calderon, who basically argues that all markets and especially the US market basically have the structure of a carry trade now. In other words, because so many people are trading the S &P 500 with various derivative products or levered ETFs or ways to basically borrow cheap money to bet on the S &P 500, that kind of the world is a carry trade now. And what's important about a carry trade, of course, is that because of the borrowing structure, when it starts to go wrong, you have to close your trade very, very quickly.

10:22so that the world now has this structure of once you hit a certain level or speed of drawdown, it will naturally pick up speed as people are forced to sell. This is just part of life today. This is the world in markets today. I'm tempted to go further than that even and say that it's not all necessarily about borrowed money, right? You know, carry trade is ultimately about taking money out of somewhere where it doesn't earn you anything exciting and putting it somewhere where you can get higher returns. And so, you know, if if I open up my little kind of savings and investment thing on my phone and, you know, you can use any of these things, they'll all give you the same results.

11:07If you say, where should I put my money today? If you're sitting in the UK, it will say, well, look, why don't you track the S &P? And I feel like there's something going on from the point of view that US markets are now so huge and so globally dominant that retail investors and professional investors everywhere are all exposed to the US market. And so the minute the US market has a bit of a wobble for whatever reason, they sell out and bring those dollars back home effectively and flip them into their home currency. So I feel like there's a kind of feedback loop going on. And, you know, maybe it's kind of exaggerated with the Japanese yen because that's such a weak currency and it's got such an unusual monetary policy framework.

11:48But maybe this happens everywhere. You know, maybe there's this kind of growing correlation between foreign currencies and the U.S. market that is something that we're not quite used to yet. I just think because the U.S. swallows pretty much every investment dollar on the planet. Yes. I mean, at the very least, you can say the S &P 500, the big American stocks are massively owned by almost every investor in the world. So there is something, there is an asset class that everyone owns. right and so if that asset class starts going wrong it is a problem for every investor in the world every portfolio in the world in a certain sense is now connected in a way that maybe wasn't true even 25 years ago or 20 years ago so that's why you know you get like one slightly iffy u.s jobs report and the whole market like globally feels the strain from it i think we're just going to have to get used to this.

12:50So let's kind of go back to like the first question we were asking here effectively, which is why do we still care about this summer shakeout that we had? Do you think it has left scars? Do you think there is a certain amount of caution that's still out there? I think you do see that in the rates market. So if you look at just straight up treasury rates or things like break even inflation expectations or, you know, weird interest rate swaps or whatever, everything in those markets tells you that expectations for economic growth are now a little bit lower. And if you look at the charts, they really fell over that weekend.

13:31So something spooked rate markets in a way that it has not recovered from, right? So there is more fear embedded in the rate markets now. So that is a scar. Another issue, of course, is what the market now thinks the Federal Reserve will do. But I think there we're sort of back to the same expectation of a single rate cut in September and maybe one or two more. So I don't think Fed expectations are now damaged and bananas. Yeah, maybe this is healthy. You know, that I think a certain amount of complacency had set in. And, you know, I think every now and then, investors need a little bit of a reminder that markets can actually fall.

14:19Yes. So, you know, hedge accordingly, reset your expectations accordingly. But, you know, all things being equal, I think the rest of this year is shaping up to be much more jittery than the start. Fun times, Rob Armstrong. It keeps us in a job. In business. I'm all in favour of market jitter from that point of view. Bad markets, good for Katie and Rob. Hooray! Listen, we're going to wrap it up and be back in a second with Long Short.

15:02All right, it's time for Long Short, that part of the show where we go long, a thing we love, short, a thing we hate. Rob, what you got? Katie, I am the kind of investor who hates gold in principle. I'm in the barbarous relic camp of gold. It's useless. It generates no income. It's just shiny and scarce. And I don't like that. However, if what we have said on this show is true, and we are in for some sustained jitters, gold despite basically being at an all-time high now should be just fine for the next couple of months so with deep regret and some hesitation i've got a short term long on gold wow i haven't picked you up on this actually but while i was on my holes i understand you went long bitcoin Yeah.

16:00And it immediately crashed. It was like the words came out. I was like long bit and it was like. Someone actually texted me while I was on holiday to say what is the job on about? I mean, my justification was that the market had gone kind of bonkers and was euphoric and that the most euphoria sensitive asset is Bitcoin. So why not? But of course, having said that, the euphoria turned and headed the other direction. Immediately. Do not follow Rob Armstrong into his trades. Never, ever. So I am short right-wing social media. So Donald Trump's Truth Social, well, his Trump Media and Technology Company, it listed like five months ago, and the stocks have hit their lowest point since then.

16:53And if you look forward to late September, Remember, former President Trump himself will start to be able to wind down some of his stake, which is worth something like$2.6 billion. Not looking good for that stock. And in addition, I wrote at the weekend about why, if you want to, or how, if you want to, you can quit X, the social media platform formerly known as Twitter. I think for a lot of people, the time has come and a lot of us should cut the cord. I've pretty much cut the cord. Katie, I'm sure if you go on Truth Social, there's a lot of ads for gold. So our trades are actually the opposite of one another.

17:33Yes. There you are. A nice bit of balance from the Unhedged podcast. For more balance in your ears, listen up again on Thursday. We'll be back in your feed then. Before we go, we have a new feature. You can now listen to the FT's latest stories and podcasts in your car with Apple CarPlay. If you've already downloaded the FT app, simply connect your iOS device to your car and you'll see the FT app logo on your Apple CarPlay screen. The FT app is available to download in the App Store if you don't already have it. Listen to the latest episodes of any podcast, including Unhedged, and top news stories updated throughout the day.

18:15More information is available on our help page at help.ft.com. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

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