Why did the Japanese stock market continue to collapse when the yen rose so sharply?

Source: Financial Time Difference

Bad news came one after another, Japan and South Korea collapsed across the board, and the US futures market also collapsed.

The Japanese stock market collapsed again after a 5.8% plunge. In the morning of August 5, the Nikkei 225 index plunged 7%, and the plunge in the Topix index triggered a circuit breaker.

Since the highs in July, the Japanese stock market, including the Nikkei 225 and the Topix index, has fallen by more than 20% in total, falling into a technical bear market.

At the same time, the volatility of the Nikkei 225 soared 50%, reaching a new high since the global crash in April 2020.

In addition, the Japanese bond market also fluctuated violently, triggering the circuit breaker mechanism.

At the same time, South Korea's KOSPI index fell more than 4%, and Australia's S&P/ASX 200 index fell 2.1%. Nasdaq 100 index futures fell 2%.

It is obvious that the global financial market has collapsed again.

There are two types of assets that are very strong, the Japanese yen and the Chinese yuan.

After soaring 1,000 points last Friday, the offshore RMB exchange rate soared nearly 500 points again, breaking through 7.12 to 7.1124. It has now recovered to around 7.13.

The US dollar continued to appreciate against the Japanese yen, once appreciating to 144.7.

Why did the global market collapse again?

In addition to the global recession trade prevailing last Friday, the carry trade collapsed, and the profit-taking was understood, there was another big news: expectations of a Middle East war have risen sharply.

First, there were a series of assassinations, the latest of which was the assassination of Ismail Hanija, the political leader of Hamas, and Fouad Chokr, the military leader of Lebanon's Hezbollah.

Then the two sides began to retaliate against each other.

On August 5, the United States told the Group of Seven that Iran might attack Israel within the next 24 hours.

Whether the Middle East war will escalate or not, the market expects that the war is coming, and then the market collapsed.

Another thing is that Buffett sold a lot of stocks and reserved a huge amount of cash.

Berkshire Hathaway reduced its holdings of Apple shares in the second quarter from 789 million shares in the first quarter to about 400 million shares, a decrease of nearly 50%.

The sale of stocks has brought the company's cash reserves to a record high of $276.9 billion (about RMB 1.98 trillion), compared with $189 billion at the end of the first quarter.

The market believes that Buffett's selling of stocks and cash reserves is a sign of a global financial crisis. He must sell stocks on the one hand and reserve a large amount of cash to buy at the bottom on the other.

Therefore, the market also sold off, causing global stock markets to continue to collapse.

Finally, why did the Japanese yen rise so sharply, but the Japanese stock market collapsed one after another?

It stands to reason that the yen soared, and Japanese yen assets should be precious. Capital has flowed into the yen in large quantities, so the Japanese stock market should rise, right?

Some people say that Japan is both an importing country and an exporting country. Energy and raw materials are imported, and industrial products such as automobiles are exported, so the yen has a range, and the Japanese economy will be good within this range, and there will be problems if it exceeds this range.

This statement makes sense, but it is not the reason for the trend of the yen and Japanese stocks, nor is it the reason for the good or bad of the Japanese economy.

To explain this "divergence", we have to start with the triggering factors of this round of "yen depreciation and Japanese stock market surge".

First of all, it is clear that the depreciation of the yen and the surge in the Japanese stock market are not the so-called "depreciation bull", not that the currency has depreciated, exports have improved, the economy has improved, and finally the stock market has risen.

This round of Japanese depreciation and Japanese stock market surge since 2021 is completely caused by "arbitrage", and the representative figure is Buffett.

How does Buffett arbitrage?

In the early stage of the yen depreciation, borrow yen to form yen liabilities, and then use the borrowed yen to buy Japan's five major trading companies (Itochu Corporation, Marubeni, Mitsubishi UFJ, Mitsui & Co., Ltd. and Sumitomo Corporation).

Why do you do this?

First, Buffett bet on the general trend of yen depreciation. He borrowed yen in the early stage of yen depreciation. When the yen depreciated, he could earn a yen exchange rate difference, which reduced the yen debt burden.

For example, when Buffett borrowed yen, 1 US dollar was equivalent to 103 yen, and finally the yen depreciated to 161, which is equivalent to a depreciation of more than 50% in the past three and a half years.

If Buffett repays the previously borrowed yen at 161, then the US dollars he uses can be reduced by at least 36%.

Originally, it took 100 US dollars to repay the yen debt, but now 64 US dollars are enough to repay the debt.

Note that the key to this operation is that the yen has been depreciating.

Secondly, after Buffett borrowed yen, why did he invest in the Japanese stock market?

In fact, to be precise, after Buffett borrowed the yen, he invested in high-dividend Japanese stocks, such as Itochu Corporation, Marubeni, Mitsubishi UFJ, Mitsui & Co., and Sumitomo Corporation.

This operation is a scam, which can be called risk-free arbitrage.

Because the Bank of Japan had not raised interest rates at that time, the interest rate of the yen was extremely low, and the interest rate of 10-year US Treasury bonds was only 0.5%. However, the dividends of these high-yield stocks in Japan were as high as 5%.

In other words, Buffett borrowed the yen to invest in the Japanese stock market, which was equivalent to a scam, and he made a profit of 4.5%.

Note that the key to this operation is that Japan's interest rates have been low.

Finally, more people followed Buffett's example, and the most significant result was that the Japanese stock market continued to soar.

As the Japanese stock market soared, investors made another profit, which was the spread profit.

Note that the key to this operation is that the Japanese stock market must rise.

Therefore, in the past three years, the yen interest rate has been low, the yen exchange rate has continuously hit record lows, and the Japanese stock market has continuously hit record highs.

But recently, the situation has reversed, and there is only one triggering factor: the rise in yen interest rates.

Japan ended its 17-year zero interest rate policy as early as March, and then after market digestion and the expectation of the Fed's policy, the yen exchange rate "bottomed out" in early July.

This logic is easy to understand. When the yen interest rate rises and the expectation of the US dollar interest rate cut rises, the yen exchange rate will end its depreciation and begin to appreciate.

This market trend is contrary to the first and second of the carry trade mentioned above.

In order to prevent the cost of yen liabilities from rising, the wise thing for investors is to pay off the yen liabilities quickly, so as to pay less interest.

In order to prevent the loss of yen exchange rate difference, the clear thing for investors is to pay off the yen liabilities quickly before the yen appreciates.

How to pay back the yen? The money they borrowed is in the Japanese stock market.

It's very simple, just sell the Japanese stock market quickly!

As the yen interest rate rises and the yen exchange rate appreciates, people become more aggressive in "closing positions" for arbitrage transactions. The first step is to sell the Japanese stock market.

So we see the contradictory market combination of "Japanese stock market crash" and "yen exchange rate appreciation".