The risk figure is the highest ever

 

Warren Buffett
The risky strategy that triggered the stock market chaos

Andreas Cervenka

Reporter and economic commentator

This is a commenting text. Analysis and positions are the writer's.

Published 2024-08-06 17.21

Historically, stock market crashes one day and big rises the next. The wild swings in the world's financial markets are no accident. The stock exchange has become a global casino where the stakes are constantly being raised.

Have you heard of “the yen-carry-trade”?

It is the name of a popular investment strategy among the world's so-called financial professionals.

So called, because the consequences of their actions, global stock market chaos affecting hundreds of millions of people, appear less professional.

Put simply, the strategy involves borrowing money in countries with low interest rates and low-valued currencies.

The most popular has been Japan because the interest rate there has been lower for a longer period of time than in any other country.

As late as the beginning of this year, interest rates were still negative in Japan.

The investors use the cheap loans to buy assets in other countries that give significantly higher returns.

Like US tech stocks for example.

It is about thousands of billions that have flowed across the world in this way.

ln the latest round, investments were based on a few assumptions: that the Bank of Japan would never raise interest rates, that the US economy would remain strong, and that the Japanese yen would remain weak or even decline.

The problem: these assumptions turned out to be wrong.

When Japan's central bank unexpectedly raised its interest rate just over a week ago, the yen rose. Those who used the strategy were taken to bed and quickly began to sell off their positions.

And when there were also figures from the US that showed a worse economy and that the interest rate is on the way down, it made the world's financial markets wobble.

It is just an example of how risks have been built up in the financial system.

In the fall of 2022, Great Britain was rocked by a crisis when the interest rate on the country's debts suddenly began to skyrocket. The then government had presented a budget that made investors frown. But what caused the panic was that UK pension funds had used a sophisticated highly leveraged scheme that created huge losses when interest rates rose rapidly.

Photo: Mark Schiefelbein/AP

How big the underlying risks in the economy are became clear when the pandemic hit. Then even the world's largest and most important market, the one for US government securities, stopped functioning. If the world's central banks had not pulled out, the coming crisis would have made 2008 look like a trifle.

Unfortunately, interest rate cuts by central banks and huge amounts of newly printed money led to new bubbles being created and risks continued to rise. In that post-pandemic world we still live.

Take the large American IT companies for example. After the fall of the last few days that triggered war headlines in all the world's media, for example, the chip manufacturer Nvidia has still risen by over 100 percent this year alone. Since autumn 2022, the rise is almost 800 percent and in five years the share has risen 2,500 percent.

The seven companies Apple, Microsoft, Nvidia, Amazon, Alphabet, Meta and Tesla are worth SEK 136,000 billion before the stock market opens on Tuesday together, or more than Europe's largest stock exchanges combined.

In November 2022, when the AI ​​service ChatGPT was released, the value of these companies was SEK 79,000 billion.

Warren Buffett. Photo: Nati Harnik / AP

What is behind this appreciation, rational calculations? Well.

One reason has to do with the fact that stock market trading these days is largely robotic. Funds that blindly shadow an index now manage more money than traditional funds managed by people.

The more a share rises, the larger share it gets in the index. Then more funds have to buy the share and the price rises. It is like a machine built to produce financial bubbles.

The seven mentioned IT companies account for a third of the stock market index in the USA.

In recent decades, financial crises and crashes have come at increasingly frequent intervals.

It is as if the world has become addicted to bubbles, wrote Financial Times columnist Martin Wolf back in 2016.

The tremors come and go but the risks continue to rise steadily. In 2024, indebtedness in the world economy will be the highest ever. Another measure of the level of risk is the value of the stock market in relation to GDP.

In July 2024, the figure in the US was 194 percent. That compares to an average of 85 percent since 1970, 105 percent before the 2007 crash, and 132 percent at the peak of the IT bubble in 2000.

This measure is called the Warren Buffet factor after the famous investment oracle from Omaha, Nebraska in the USA. He has called the number the best way to see if the stock market is overvalued.

In recent months, Warren Buffett, who has become known as something of an eternal optimist who buys when others are selling, has sold off stocks and is sitting on a record-breaking cash balance.

The stakes seem to have become too high even for him.