News of the week summary - 08/11/2024

Global stock markets plunge 

Global stock markets experienced a dramatic decline this week, driven by rising concerns about a potential US recession. The sell-off was particularly severe in Japan, where the Topix index dropped 12.2%, marking its worst day since the 1987 “Black Monday” crash. This sharp decline erased the index’s gains for the year and set off a chain reaction across global markets.

In the US, the tech-heavy Nasdaq Composite fell 6.3% at the opening, while the S&P 500 dropped 4.1% before slightly recovering. The market turmoil stems from worries that the Federal Reserve may have been too slow to address signs of economic weakness. Investors are now anticipating up to five quarter-point rate cuts by the end of the year, with some even speculating on an emergency rate cut before the Fed’s next meeting in September. This speculation has intensified market volatility.

The recent market surge earlier in the year, driven by optimism about artificial intelligence and a strong performance by tech stocks, has now given way to fears that the rapid rise in equity valuations was unsustainable. The S&P 500, which had surged nearly 20% to a record high in July, has since fallen more than 8% from that peak.

Adding to the market’s woes, major tech stocks, which have driven much of the market’s recent gains, are under pressure. Apple, Microsoft, Alphabet, Amazon, Tesla, Meta, and Nvidia—collectively known as the “Magnificent Seven”—accounted for over half of the S&P 500’s year-to-date returns through July. However, these stocks are now facing significant declines, contributing to the broader market sell-off.

The situation has been exacerbated by the unwinding of the yen carry trade. 

The yen carry trade consists of borrowing Japanese yen, because interest rates in Japan are historically very low due to fears of delation. The money is then exchanged to another currency which can be invested in a country with higher interest rates. Investors profit from the difference between the low cost of borrowing and the higher returns earned on the investments. However, if the yen strengthens or interest rates rise, it can increase the cost of repaying the yen and reduce or eliminate profits.  This strategy has gained immense popularity over the past three years due to Japan's ultra-low rates, contrasting with climbing rates in the rest of the world to fight inflation. 

The Bank of Japan's rate increase last week and subsequent signals of potential further tightening have sparked changes in the Yen price and market volatility, forcing investors to unwind their carry trade. The currency has strengthened by around 12% since mid-july. This has led to a rapid and widespread sell-off of assets previously funded through yen borrowing. Analysts estimate that the dollar-yen carry trade alone is valued at around $500 billion, with a significant portion of this amount being liquidated recently.

However, recent comments from Bank of Japan Deputy Governor Shinichi Uchida, suggesting that further rate hikes might be unlikely in the near term, led to a temporary stabilization. The yen fell from around ¥144.7 to ¥146.82 against the dollar following these remarks, and Japanese stocks saw a rebound.

Despite the recent rally in Japanese indices, including the Topix and Nikkei 225, which experienced their steepest one-day gains in nearly 16 years, the markets remain highly sensitive. The Topix had seen a dramatic 20% drop over three sessions from late August to early September, reflecting the severe impact of the unwinding.

The yen's appreciation and the subsequent unwinding of carry trades have also affected other markets. The global sell-off has impacted everything from emerging market currencies to US tech stocks. The broader financial markets are now grappling with uncertainty over the US economic outlook and potential recession fears.

EU states will support tariffs on Chinese electric cars

The European Union is on track to impose new tariffs on Chinese electric vehicles (EVs), with a decision expected in late October and implementation likely by November. This move aims to protect the European automotive industry from the rapidly growing market share of Chinese EVs, which are perceived to benefit from substantial subsidies provided by the Chinese government (a violation of the World Trade Organisation's rules).

Dombrovskis noted that EU member states are rallying behind the tariffs as a measure to level the playing field for European car manufacturers. This follows concerns that Chinese EVs, backed by substantial state support, are undermining the competitiveness of local carmakers. The tariffs could reach up to 37.6%, though the average is anticipated to be around 20.8% on top of the current 10% duty.

China's response has been one of frustration, with the Commerce Minister expressing a desire for negotiations. Despite several rounds of discussions, little progress has been made beyond technical details. The upcoming vote will determine whether the tariffs will proceed, with a requirement for 15 countries representing at least 65% of the EU’s population to block the measure. Currently, support for the tariffs appears strong, despite some reservations from major car-producing nations like Germany.

German carmakers, who have significant investments in China, have voiced concerns about potential retaliation from Beijing. Nonetheless, the EU chief of trade emphasized that the goal is not to exclude Chinese products but to ensure fair competition. He pointed out that the EU market remains more accessible to Chinese goods than the Chinese market is to European products, contributing to a €293 billion trade surplus in goods for the EU in 2023.

In response to the potential tariffs, some Chinese firms have started establishing manufacturing facilities in the EU. However, the EU trade chief cautioned that these new plants must meet stringent EU rules to qualify for tariff exemptions, ensuring that a significant portion of the vehicle’s value is added within the EU.

Buffett sells $50B of Apple stock

Warren Buffett’s fund Berkshire Hathaway, has reduced its stake in Apple by half, selling off around $50 billion worth of shares. It had first started investing in the company 8 years ago. This move is part of a larger strategy where Berkshire offloaded $76 billion in stocks during the second quarter. 

The cash from these stock sales has pushed Berkshire’s cash reserves to a record $277 billion, a rise of $88 billion from the prior quarter. This influx of cash is being redirected into short-term US Treasuries, showing Buffett’s cautious approach towards equity markets.

Buffett’s decision to trim Berkshire’s Apple holdings aligns with his broader investment strategy, which emphasizes valuation discipline. Analysts suggest that the move might also be influenced by potential future tax implications on capital gains. 

In addition to the Apple sale, Berkshire Hathaway has been gradually reducing its position in other investments. For instance, the company sold $3.8 billion worth of Bank of America shares recently.