Hedge Funds’ Fall Gives Japanese Currency a Lift
In the last couple of days as global markets tumbled in succession like so many bowling pins, a particularly strange phenomenon has played itself out in Japan.
While the Nikkei-225 stock index plunged in line with other markets to close at a 12-year low of 13,915.63 on Friday, the yen hit a one-month high of 140.48 to the dollar before easing back to 141.85 in New York trading.
Even by Japanese standards, this is a bit odd, because currencies generally weaken in line with falling markets.
“On the face of it, it really doesn’t make sense,” said Miron Mushkat, vice chairman of Indocam Asia Asset Management based in Hong Kong.
Did international investors suddenly go crazy and decide that Japan’s problems weren’t so bad after all, that its trillion-dollar financial crisis was chump change and that the giant, troubled economy actually smelled like roses?
In fact, at least part of the answer lies in an interesting technical anomaly, analysts say. Essentially, over the last few months Japan’s very weakness has made it highly attractive as a feeding station for the great white sharks of international finance--hedge funds--which have used the yen to finance their high-risk global arbitrage activities.
When Russian markets imploded and sent world markets reeling Thursday, however, many hedge funds were caught off guard and forced to beat a quick retreat, prompting what is expected to be a temporary uptick at best for Japan’s troubled currency.
The misstep also provides insight into the flexibility and reach of global hedge funds, which have been blamed for all manner of evil, including starting the Asian financial crisis, and which have been locked in a high-stakes game of chicken with Hong Kong over that territory’s currency.
Hedge funds have been interested in Japan exactly because it’s in such dire shape. Japan’s moribund economy has resulted in few Japanese investing in new factories or restaurants. This in turn has driven interest rates to absurd lows, with the annualized yield on Japan’s benchmark 10-year government bonds falling to just 1.06% Friday, a level reportedly not seen anywhere in the world in centuries. On top of that, the yen has slid more than 20% in the past year, recently bottoming near 148 to the dollar.
Smelling opportunity, hedge funds have moved in aggressively to borrow yen. Not only does this provide them with incredibly cheap money to play with, but if the yen depreciates further, they effectively get paid to use the money, because the loan becomes cheaper to pay back in dollar terms. Understand all that and you’re starting to think like a speculator.
With the inexpensive money in hand, many funds then went out in recent months and bought stocks in Russia and other emerging economies. “All they have to do is find an investment with even a modest return and they look pretty good,” said Peter Morgan, economist with HSBC Securities.
The easy money suddenly evaporated this week, however, when risky emerging markets tanked, revealing a flaw in this house of cards. Once Russian and other stocks imploded, Japanese lenders started demanding more yen, because the value of the hedge funds’ loan collateral was eroding.
“Once emerging markets looked like they were collapsing, [hedge funds] bought back the yen” to meet margin calls, said Yasunari Ueno, chief economist with Fuji Securities Co.
In the process, many hedge funds reportedly got squeezed. Global hedge funds may hold $50 billion to $60 billion at any one time, according to one market source, although this understates their reach because they are so highly leveraged.
The Soros Contra Fund this week said it lost some 10% of its value, or about $2 billion, on Russian investments over the past year.
Another factor behind the yen’s sudden strength, several analysts said, is that risk-averse Japanese investors were bringing their capital home, given that markets everywhere are shaky and there’s at least a certain comfort level in being home.
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Taking Stock of a Dismal Week
Stocks worldwide suffered some of their worst losses of the post-World War II era this week, amid fear over Russia’s economic collapse and spreading turmoil in global markets.
Blue Chips: Deepest Slide Since ’90
The Standard & Poor’s 500 index is in its steepest decline since the bear market of 1990, which was triggered by Iraq’s invasion of Kuwait. Major S&P; declines in the ‘90s:
Since July 17: -13.4%
Oct. 1997: -10.9%
Feb.-April 1997: -9.6%
May-July 1996: -7.6%
Feb.-April 1994: -8.9%
July-Oct. 1990: -19.9%
Emerging Markets: Mounting Losses
Investors in stock mutual funds that own emerging-market shares now have lost nearly half of their money over the last year. One-week and 12-month losses in key fund categories, through Thursday:
Emerging markets (diversified)
Week loss: -13.4%
12-month loss: -45.9%
*
Latin American
Week loss: -16.3%
12-month loss: -48.8%
*
Asia (excluding Japan)
Week loss: -3.6
12-month loss: -53.4
Even the ‘Favorites’ Sink
By Friday, investors were dumping even some of their favorite stocks of the recent bull run. A look at some of Friday’s big losers:
*--*
52-week Friday close Friday Stock high and change pct. change Yahoo Inc. $103.75 $83.06, -$8.00 -8.8% Apple Computer 43.75 34.19, -3.31 -8.8 America Online 140.50 96.25, -8.75 -8.3 Dell Computer 129.38 118.75, -6.31 -5.0 Gap Inc. 68.00 56.38, -2.63 -4.5 Wal-Mart 69.81 65.38, -2.50 -3.7 Microsoft 119.63 105.25, -4.00 -3.7 Colgate-Palmolive 98.88 77.94, -2.94 -3.6 Coca-Cola 88.94 72.75, -2.00 -2.7 Lucent Tech. 108.50 81.00, -1.69 -2.0 S&P; 500 index 1,186.75 1,027.25, -15.34 -1.5
*--*
Source: Bloomberg News; Lipper Analytical Services
Say That a Yen?
Currency speculators took a short bath in Japan, leading to a two-day anomaly in which the yen surged as stocks crashed. Daily closes of the Nikkei-225 stock index and the yen against the dollar:
Yen per dollar
Friday: 141.85
*
Nikkei index
Friday: 13,915.63
Source: Bloomberg News
