Nowhere To Hide? Turmoil Presents Tough Choices To Investors
The latest episode of volatility in financial markets has been a defining characteristic of the trading environment since the beginning of the year. In this environment, key relationships and trends of previous periods – such as the unquestioning belief in the US dollar uptrend or confidence in the mostly positive outlook for developed economies and their stock markets – have been seriously shaken. Many investors are looking for safe havens as shelters in which to weather this storm and some of the latest market moves are giving us some hints where safety lies.
In the currency market, the main beneficiary has been the yen. Of course it hasn’t been a straight line up for the Japanese currency and there have been some big fluctuations not least because of the action by the Bank of Japan. The central bank recently pushed interest rates in negative territory in a move that surprised markets and drove the yen sharply lower for a brief period. Continuing risk aversion helped the yen to recover however. This is creating a headache for the Japanese authorities as given the weak state of the economy and near-zero inflation, a stronger currency is the last thing that the country needs. Therefore, one can count on some kickback from the Japanese authorities if the yen gets stronger – either in terms of actual market intervention or with further monetary loosening from the Bank of Japan. So even though the yen is a preferred safe haven among investors, the Japanese themselves will need to react to stop it from rising too high so there is also this danger for those sheltering in the yen.
The other currency that has had a positive performance this year – particularly versus the US dollar has been the euro. The euro has not been featured as much as a safe haven, although it has been the most fashionable currency to use for funding purposes for leveraged investors into risky assets. As such bets unwind, the euro should gain. In the euro’s case as well, the European Central Bank would like to dissuade a sharp appreciation given very low inflation and the positive but mediocre growth rates posted by the region. Therefore, it could cut interest rates deeper into negative territory or even expand the size and the scope of its already substantial quantitative easing program. Another potential issue for the euro’s status as a safe haven is that the Eurozone could find itself once again in the center of the global financial storm. The Eurozone periphery crisis has not totally gone away but is lying low for now. There have been negative political and economic developments in countries such as Portugal, Spain and Greece. Although it’s not clear that the Eurozone crisis can depress the value of the euro for a sustained period, during the peaks of the crisis (e.g. when speculation was rife that Greece would be kicked out of the Eurozone during the first half of July of 2015), the euro can come under intense pressure, taking away from its safe haven appeal.
Furthermore, there is also the issue of the state of the region’s banking system as a number of banks particularly in the periphery are saddled with bad loans. It would be awkward if the region faced a banking crisis but at the same time its currency was viewed as a safe haven.
A traditional safe haven currency is the Swiss franc, but it has not done as well as the euro or the yen so far during the turmoil. Overall the Swiss economy and the currency have not been as negatively affected by the ‘franc shock’ of January 2015. In the case of the franc rapidly gaining strength however, the Swiss National Bank (SNB) could also become a factor that could dissuade the currency from becoming much stronger and hurting the local economy. The strong franc is already a major challenge for the Swiss so there could be resistance to its further strengthening.
Outside the currency market, government bonds are also some of the favorite safe havens as the governments represent the safest credit risk among bond issuers. Recently however in certain countries and regions such as the Eurozone, Japan and Switzerland, negative rates have been registered for many different government bonds extending to relatively long maturities. The Japanese government 10-Year bond yield briefly dipped below zero today; the first G7 10-year bond yield to make it into negative territory. Other countries’ bonds could follow the Japanese lead – particularly if negative interest rates become a more established tool of monetary policy. Some investors may have a problem though to invest in securities that ‘guarantee’ a negative return – unless they can sell them on with a profit at an even deeper negative yield.
Finally, gold and silver have been the best performing assets this year. Some investors though have a problem accepting precious metals as assets to have in a modern financial portfolio. Despite their very long history, precious metals are still perceived as ‘barbarous relics’ by many investors as they don’t yield any income either. Furthermore, other investors may have a problem investing in an asset such as gold that has been in such a well-defined downtrend for more than 4 years. Gold is currently trying to overcome the $1200 level and the next critical test for it will be the $1300-1310 area, which would give more confidence to bulls as it would represent a 1 ½ -year high.
Sometimes boring is the safest option. Therefore, devoting funds to a well-persified multi-currency cash portfolio will likely be the least risky option compared to the safe havens that were discussed above. This would allow investors to have dry power to deploy in the case of steep declines in the prices of risk assets and would also minimize the chance of capital losses as losses in one currency would be offset by gains in another. With inflation so low around the world, holding cash may not yield any interest but at least there won’t be much loss of purchasing power either.