In the old days of the 2000s, there was a simple slogan called “Risk/Don’t Risk”. Most of the time between 2010 and 2020, the switch was set to “on” and was to make money by putting one’s chips into the stock and a handful. From other risk assets of various shapes and sizes. Every now and then something happened – the eurozone crisis, the devaluation of the Chinese currency or what happened to you, and the switch was flipped to “off”. For most of us, the kill switch wasn’t long enough to merit a deep-rooted change in portfolio strategy. This was, after all, the height of “Fed Mode” – providing liquidity (or sometimes nothing more than kind words and assurances) to support market risk. If you had a conservative-type portfolio in terms of growth with a decent allocation to high-quality fixed-income securities, that was enough to get rid of the cyclical whims of the stock markets.
All that glitters is neither gold nor yen
For those who wanted to be more creative with hedging, there were a few tried and true defensive strategies to follow. Two assets that have long received regular financial media coverage during the decline of risky assets are gold and the Japanese yen, both of which are traditionally thought of as relatively safe places to be in times of economic turmoil. In the 1970s, for example, an investor who had nothing but gold and yen in his portfolio outperformed someone with a traditional 60/40 stake in stocks and bonds.
Not much today. The chart below shows the performance of gold, the yen, and the S&P 500 for the current year so far. Doesn’t seem like a hedge.
True – Gold rallied again in February and March when the stock market went through its first down cycle of the year. But since then, it has fallen more than 15 percent from its high in early March, which no hedge asset would want. If anything, gold has more or less tracked the stock market as the latter lost ground on its way to the bear market in mid-June.
Elaine has his own story. Japan’s chronically low economy – and sometimes inflation – seems in theory an attractive port in a storm while inflation is rising elsewhere in the world. But the yen is down more than 21 percent against the US dollar and is trading around a quarter-century low against the dollar.
The explanation is reasonably straightforward. While the Federal Reserve, along with central banks in most other advanced economies, is pursuing a tight monetary tightening policy to combat inflation, the Bank of Japan continues to inject massive stimulus into the system by buying bonds and stocks. Japan faces a number of unique economic factors (for now, anyway) that present enormous obstacles to robust growth and price inflation. With interest rates rising elsewhere in the world, Japanese sovereign debt remains solid at around zero percent (the 10-year Japanese government bond yield is a quarter of a percent today, compared to 3.25 percent for US Treasuries and up to 1.5 percent for German bonds, which was a year ago carry a negative return).
It’s not just about rates. After all, US interest rates rose sharply in the 1970s as well, yet that doesn’t seem to diminish the magic of gold and the yen. But there were other circumstances at that time that could not be compared to those today. In fact, the strength of both origins at that time can be traced back directly to that day in August of 1971 when the United States broke off the gold standard, bringing down the entire edifice of the macroeconomic system in place since the end of World War II. .
When the dollar was able to float freely against other currencies, particularly the yen and the German mark, the pressures that had been building up for years were removed, and these currencies rose as the dollar depreciated. As for gold itself, its luster has grown as a predictable store of value in a volatile climate. Last week in this commentary, we talked about Fed Chairman Arthur Burns’ choppy monetary policy during the first half of the decade. Interest rates have gone up and down as the Fed’s policy shifts from fighting inflation to fighting recession, but gold has held steady. Even late in the decade, when the Fed’s more aggressive monetary policy pushed interest rates into their teens and beyond, the price of gold continued to rise as investors sought refuge from a world they seemed to understand less and less.
which was then. We have many economic, social, and geopolitical challenges today, but they differ in many important ways from those of fifty years ago. Times have changed. What worked yesterday doesn’t necessarily work well today or tomorrow.
Editor’s note: This article’s bulleted summary was selected by searching for alpha editors.