MARKETS & BOARDS

While the inflation cooled to 2.9% (lower than expected) The Federal Reserve just got the green-light to cut interest rates in September -- September would look like it is a flip-on between 50 and 25 percent cuts for the Fed-Rates to ease-off.

i.e. Today's CPI data release showed a less severe increase in inflation, which could pave the way for The Federal Reserve Board to begin lowering interest rates as early as September.

Let’s strongly hope that the Fed keeps going-on decisively over the next month(s).

Yes, the post-pandemic “new-normal” markets are slowly moving into “real-normal”!

After-all it’s about balancing and mitigating the “risks” on-time!

So-much likely is the role of our Global Corporate Boards and their holistic, effective Governance:

Watching, understanding and having the ability to decipher (Global) Markets is crucial for the Boards.

Here’s a Market Case Study [the most recent one]

How Japan’s Yen Carry Trade Crashed Global Markets [last week]

The global mini-crash on Monday, August 5, 2024, where stocks plummeted before mostly rebounding, cannot be attributed to a single cause. However, a significant factor was a long-standing foreign exchange strategy that abruptly became problematic when Japan's central bank and government attempted to rescue the yen from a worsening decline.

The turmoil that shook global markets last week was largely driven by a market strategy known as the "Carry Trade".        

Japan's benchmark Nikkei 225 tumbled 12.4% on Monday, and markets in Europe and North America also suffered significant losses as traders sold off stocks to cover the increasing risks associated with investments funded by low-cost loans, predominantly in Japanese yen. Although markets regained much of their losses on Tuesday, August 6, 2024, the effects still linger.

The markets were rattled by a mix of factors, including fears of a potential recession in the United States, the world's largest economy, and concerns that technology stocks have surged too high this year.

However, the scale of the declines was amplified by the rush to sell U.S. dollars due to carry trade deals that had previously driven markets to record highs.

So – What are CARRY TRADES?

“Carry trades involve borrowing money at a low interest rate in one currency to achieve higher returns by investing in assets denominated in another currency.” A recent example of this strategy is borrowing Japanese yen, with the expectation that the currency will stay weak against the U.S. dollar and that Japanese interest rates will remain low. The borrowed yen would then be invested in U.S. stocks and Treasury bonds, with the aim of earning a higher return.

Why have traders been closing their Carry Trades?

The core principle behind a carry trade is the difference in interest rates between two currencies. The Bank of Japan has kept its interest rates at or near zero for years to encourage spending and stimulate economic growth. However, last week, it raised its main interest rate from nearly zero. Higher interest rates typically increase the value of a country's currency, and as a result, the Japanese yen surged against the U.S. dollar.

This led traders to rush to sell higher-risk, dollar-denominated assets to cover the suddenly higher borrowing costs, as well as losses from changes in foreign exchange rates and declining asset values due to falling share prices.

Additionally, hedge funds engaged in carry trades rely on computer models to optimize their returns relative to risks. To maintain acceptable risk levels, they were forced to sell shares.

Why do Carry Trades have a disproportionately large impact on markets?

Carry Trades are most advantageous when foreign exchange rates are relatively stable, allowing investors to capitalize on higher-yielding opportunities, such as the recent surge in stock prices in countries like the United States. However, the recent market turmoil forced traders to cover their debts by buying yen and other carry trade currencies, leading them to sell off a greater share of the higher-risk assets they had acquired under more favorable conditions.

Carry Trades can be highly profitable when stocks or other investments are rising, but losses can quickly escalate when thousands of traders are compelled to sell assets simultaneously.

As Stephen Innes of SPI Asset Management put it, "A massive global carry trade unwind was the spark that ignited this market meltdown. A defining feature of these self-reinforcing market crashes is the vicious cycle where a sell-off exacerbates realized volatility." [Source: www.AP.org ]

What are the future risks associated with Carry Trades?

The future risks associated with carry trades primarily revolve around several factors:

• Exchange Rate Volatility
• Interest Rate Changes
• Market Volatility and Liquidity Risks
• Leverage Risks
• Economic and Policy Uncertainty

The gap between Japan's main interest rate, now at 0.25%, and the Federal Reserve’s benchmark rate of 5%-5.25% remains significant but is expected to narrow as the Fed lowers rates and Japan raises its own. Financial markets appeared to stabilize on Tuesday, with Japan’s Nikkei 225 index rising by 10.2% and other markets mostly gaining. Analysts are divided on whether this wave of market volatility has passed or if more turbulence lies ahead.

Nevertheless, carry trades have been a longstanding strategy, contributing to the meltdown of Iceland’s financial sector in 2007-2008, when investors borrowed in yen or Swiss francs to capitalize on high Icelandic interest rates. During the latest market turmoil, Mexico, another focal point of Yen Carry Trades, saw its Peso drop by more than 6%.

While Carry Trades can be profitable, they carry substantial risks that require careful management and monitoring of global economic and market conditions. This popular but potentially complex trading strategy is likely to remain a wildcard for investors, especially during periods of high market volatility.

Carry Concerns

In the currency markets, J.P. 摩根 Chase & Co has cautioned that the recent unwinding of "Carry Trades" may continue, given that the yen is still one of the most undervalued currencies.

This trade-strategy involves borrowing at low interest rates in Japan to invest in higher-yielding assets abroad. Over the past week, it has faced significant challenges as yen volatility has increased.

THE ROLE OF CORPORATE BOARDS

In the context of global financial turmoil caused by events like the unwinding of carry trades, the role of Global Corporate Boards - the Board of Directors along with their CEO, becomes critical in steering the company through such challenges.

Here’s how their stewardship and foresight are essential:

1. Risk Management and Oversight

• Proactive Risk Assessment: Boards must ensure that comprehensive risk management frameworks are in place, particularly to identify and mitigate exposure to financial market volatilities like carry trades. This includes stress-testing the company’s financial resilience against sharp currency fluctuations and interest rate changes.
• Oversight of Financial Strategies: The Board should closely monitor the company’s financial strategies, particularly those involving significant leverage or exposure to foreign exchange risks. In volatile market conditions, these strategies can become high-risk, as seen with the recent yen carry trade unwind. Directors must ensure that the company’s risk appetite is clearly defined and aligned with long-term sustainability.

2. Strategic Decision-Making

• Adjusting Investment Strategies: In times of financial turmoil, Boards must work with the CEO to reassess and possibly re-calibrate the company’s investment strategies. For example, if a company is heavily reliant on debt-financed growth or high-risk investments, the Board should consider shifting towards more conservative or diversified approaches to protect the company’s assets and ensure liquidity.
• Crisis Response Planning: Boards should be prepared to activate crisis management plans that include clear communication strategies, both internally and externally. They should guide the CEO in making timely decisions that can stabilize the company during market downturns.

3. Corporate Governance and Accountability

• Ethical Leadership: During volatile market periods, it’s crucial that Boards uphold strong corporate governance principles, ensuring that the company operates transparently and ethically. This includes making decisions that protect the interests of all stakeholders, not just shareholders, and avoiding actions that could lead to reputational damage or legal repercussions.
• Board Composition and Expertise: The Board should include members with the financial acumen and global market experience necessary to navigate complex economic environments. This expertise is vital for understanding the implications of strategies like carry trades and guiding the company through associated risks.

4. Stakeholder Communication

• Transparent Communication: The Board, along with the CEO, should maintain open and honest communication with shareholders, employees, and other stakeholders about the company’s exposure to market risks and the steps being taken to mitigate them. Transparency builds trust and can prevent panic during market downturns.
• Engagement with Regulators: Boards should ensure that the company is in compliance with regulatory requirements, particularly in relation to financial disclosures and risk management practices. Engaging proactively with regulators can also provide insights into potential policy changes that could impact the company’s operations.

5. Foresight and Long-Term Planning

• Scenario Planning: Boards should encourage long-term planning that includes scenario analysis for various market conditions, including worst-case scenarios like those triggered by a sudden unwinding of carry trades. This foresight can help the company remain resilient and agile, even in the face of unexpected global financial shocks.
• Sustainable Growth Focus: Ultimately, Boards and CEOs must prioritize sustainable growth over short-term gains, particularly in volatile markets. This involves balancing profitability with risk management and ensuring that the company’s strategic direction aligns with its long-term vision.

Global Corporate Boards and their CEOs must exhibit strong leadership, robust risk management, and strategic foresight to navigate the complexities of global market volatility.

Their actions not only influence the stability and success of their own companies but also contribute to a broader market confidence and economic stability.

BONUS: INVESTOR INSIGHTS

HOW INVESTORS ARE SAFEGUARDING AGAINST FUTURE MARKET CRASHES?

When markets crash, especially due to factors like carry trades, financial experts offer a range of advice on *what you should—and shouldn’t—do to navigate the volatility.

What You Should Do:        

1. Stay Calm and Avoid Overreacting: It's crucial not to make impulsive decisions during a market crash. Take a moment to assess your portfolio and understand the factors driving the downturn. Panicking can lead to decisions you might later regret, such as selling assets at a low point.
2. Review and Re-balance Your Portfolio: Use the opportunity to evaluate whether your investments are still aligned with your financial goals. Consider reducing leverage if you’ve borrowed to invest and diversify your holdings to include safer assets like bonds. This helps in managing risk during turbulent times.
3. Consider Buying the Dip: If you have cash reserves, market crashes can present buying opportunities, as many stocks may become undervalued. Some experts suggest looking into sectors that have under-performed, such as global small and mid-cap stocks, or regions like Japan and Europe that might recover as markets stabilize.
4. Hedge Against Further Losses: In the wake of the recent global market mayhem, many traders rushed to insure their portfolios against extreme crashes. One popular strategy is "Black-Swan Hedging," where funds like the Cambria Investment Management Tail Risk ETF become sought after, as they offer protection against significant downturns.

What You Shouldn’t Do:        

1. Don’t Over-Concentrate: Avoid having too much exposure to a single sector or asset class. For example, portfolios heavily weighted in high-risk assets, like tech stocks, can suffer large draw-downs during market crashes.
2. Don’t Increase Leverage: In a volatile market, increasing your borrowing to invest can amplify losses. If you’ve used leverage, consider scaling it back to reduce the risk of margin calls or forced sales at inopportune times.
3. Avoid Market Timing: Trying to predict the exact bottom of the market is extremely difficult. Instead of attempting to time your entry perfectly, focus on a long-term investment strategy that aligns with your financial goals and risk tolerance.

These strategies help in managing the financial stress associated with market downturns, especially when they are driven by complex factors like the unwinding of carry trades.

Apparently, businesses shall remember that the global economy has been crossover by the “policy-making” – and hence the Markets!?

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"Bo" Subodh Dalvi, Board Director | Executive Advisor | Harvard Business Review ADVISORY COUNCIL | Impact●Investor |

*Sources: ?

Wealth Management - https://www.wealthmanagement.com/equities/what-bankers-say-you-should-and-shouldn-t-do-when-markets-crash

Advisor Perspectives - https://www.advisorperspectives.com/articles/2024/08/06/bankers-say-should-and-shouldnt-do-markets-crash?topic=exchange-traded-products ?