The financial markets held their breath over significant price volatility last month. The value of higher-risk investments fell at the end of July, while secure asset classes made gains. Although financial market conditions have now settled down again somewhat, the outlook has changed.

Carry trades in big trouble

Beleaguered carry trades in Japanese yen were at the center of last month’s turbulent events. These inexpensive loans in yen to purchase other investments come under pressure if the Japanese currency appreciates strongly or the value of the investments made, such as tech stock like NVIDIA, falls sharply. In such situations, the loans taken out in yen often have to be repaid by quickly offloading the investments purchased. This unwinding of the carry trades is caused by appreciation of the Japanese currency and losses on the investments made. This pattern of events has been very evident over recent weeks. 

Tech stocks under pressure

In addition to the unwinding of the carry trades, disappointing quarterly reports by major tech companies benefiting from the AI boom, such as Microsoft, also contributed to the market turmoil. Until early July, it seemed as though the profit expectations of these companies would continue rising endlessly. However, the latest reports put a dampener on these expectations. It’s becoming increasingly clear that investment in artificial intelligence still has to pay off. We expressed scepticism over the high expectations in May and adjusted our positioning in the tech-heavy US equity market in favour of value stocks. In addition to significant price corrections to tech stocks after the quarterly reports, the latest development in the competition law investigations, with the judgement on the Google case in the USA, also confirmed our positioning. This development may strengthen the competition, making it harder to generate high profit levels favoured by monopoly positions. Even after the recent recovery on the financial markets, returning to the previous trend may prove difficult in view of these prospects. That’s why we continue to favour value stocks.

Growing fears of recession in the USA

Growing concerns over a slowdown in the US economy proved challenging for the financial markets last month. This realization also appears to be gradually setting in on the financial markets. Equity prices fell again worldwide after the publication of weaker US labour market data at the end of July. In contrast to the rest of the current year so far, bad economic news was also deemed a negative development for the financial markets in July. This situation did not come as a surprise to us. We’ve been warning of the risk of an economic slowdown in the USA for some time and have adopted appropriate defensive positioning. With the heightened risk of recession in the USA, lower capital market interest rates are now much more likely, prompting us to neutralize our bond allocation by purchasing US government bonds.

Japanese yen has potential to appreciate

During the recent turmoil related to the unwinding of carry trades, the Japanese yen made strong gains. However, unlike other asset classes, it has failed to recover since the turmoil. In our view, the Japanese currency is unlikely to return to its previous level of weakness. Instead, the yen looks set to make further gains, as it is still significantly undervalued and has shown recent upward momentum. For this reason, we recommend purchasing Japanese yen.

Performance of asset classes

Our positioning – Swiss focus