In the latest episode of the Pinnacle Digest podcast, host Alexander Smith engages in a timely and insightful discussion with Michael A. Gayed, portfolio manager and author of the Lead-Lag Report. Known for his bold market predictions, Gayed shares his thoughts on the current state of the financial markets, particularly in light of the ‘yen-carry trade’ drama, and looming credit risks.
As markets face ongoing volatility, Gayed offers a critical analysis of the disconnect between credit markets and stock performance, while exploring the potential outcomes of these economic trends. From rising unemployment to the possibility of a soft or hard landing, this conversation dives deep into the forces shaping the global economy and what investors should expect in the months ahead.
Before the recent market crash in late July/early August, Gayed was among the most outspoken commentators on the dangers brewing from the yen-carry trade. Despite the bullish rally throughout August, he doesn’t believe the equity markets are out of the woods yet.
Michael Gayed Gives Update on Yen Carry Trade
The ‘Yen Carry Trade’ is a popular financial strategy in global markets. Investors borrow money in a currency with low interest rates, such as the Japanese yen, and then invest in assets denominated in a currency with higher interest rates, such as the U.S. dollar or emerging market currencies. Here is a hypothetical example:
If a U.S. investor borrows yen at an interest rate of 0.5% and invests the funds in U.S. Treasury bonds yielding 4%, the investor earns a 3.5% return, assuming the exchange rate remains stable.
In summary, the yen carry trade is significant in global markets due to its influence on currency rates, market liquidity, and the interconnected risks between economies, especially during periods of market volatility. Gayed has long forecast that the yen carry trade would reverse.
Credit Risks Still Loom Large
Concerning the rising risk of a major credit event, Michael states,
“The market will do everything it can to make everyone look foolish, the bulls and the bears…”
“This kind of price action is what you see in a high volatility regime.”
Stocks Are Acting Like There Is Default Risk
With unemployment rising, Gayed believes the long-awaited recession may finally be here. He notes that while stocks continue to act as if a credit event is looming, credit markets say there is no default risk. Gayed argues that one of these must be wrong and that this disconnect cannot last. To that point, Gayed expects ‘aftershocks’ in the stock market to continue through the coming months.
Soft or Hard Landing for The Economy?
Michael Gayed believes that because yields are dropping across major economies, this suggests an economic slowdown or recession is here… and that,
“Every hard landing looks like a soft landing until it’s not.”
Bond Market Still Says There is No Default Risk
Until bankruptcy risk rises, Gayed doesn’t believe the Fed will act too quickly regarding rate cuts. However, Gayed is keeping an eye on junk debt and explains that if lenders of capital are not worried about getting their money back from highly leveraged companies, credit spreads will remain tight. Gayed expects those spreads to widen as concern rises over creditworthiness.
Can the Fed Save the Markets?
In short, Michael Gayed believes that if the Fed begins easing again, it may be able to save the markets. He doesn’t think it is a guarantee, but it is definitely possible. He states in the pod,
“It is hard to imagine a scenario where the Fed gets it right because in many ways they have to react to the damage already being done unless they ultimately end up putting more fuel on the inflation fire.”
Election 2024 Update
Gayed explains why Democrats have historically been better for the markets than Republicans, and yet he doesn’t really care who wins in November…
Michael outlines his portfolio protection strategies in a volatile market while explaining why investors aren’t excited about gold. He explicitly cites recency bias and the fact that gold and gold equities were effectively dead money for ten years. Overcoming that stigma and reality will take some time and several more winning quarters for gold.
Gayed also shares his thoughts on Bitcoin:
“There is no such thing as a store of value. It doesn’t exist because everything has tail risk. Everything has extremes, positive or negative.“
Gayed Staying Focused on Credit Risks
Lastly, Gayed agrees with our thesis that U.S. dollar devaluation will continue. He would love to see the U.S. dollar roll over, citing the tailwind a falling dollar creates when investing in European and emerging markets.
Gayed believes that once the Fed starts cutting rates, the Greenback will fall. Coming full circle, he reminds us that widening credit spreads will be a sign that credit risk is rising and the markets are on the precipice of a meaningful correction. Ultimately, while Gayed sees opportunities for the Fed to intervene and stabilize markets, his analysis leaves us with the impression that significant challenges are on the horizon for equity markets.
