This is an audio transcript of the Unhedged podcast episode: ‘Markets resume previously scheduled exuberance’

Katie Martin
You know that feeling when you turn your back for 10 minutes and all hell breaks loose? Well, that. I went on holiday, very nice it was too, and the markets went loopy.

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Adding to the loopiness, they’re pretty much back to where they started. How on earth does that all make sense? Today on the show, keep up at the back. The market mini crash is old news. We’re gonna talk about why markets have recovered and what it all means.

This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I’m Katie Martin, a markets columnist at FT towers here in London. And I’m happy to say I’m joined by the estimable and finely dressed Rob Armstrong. Rob, I have decided for one week only to be nice to you, not least because you’re out of the studio this week, so you’ve got a slightly wobbly internet connection. Where on earth are you?

Robert Armstrong
I have been drawn out to eastern Long Island by family business, and so it appears they’ve just discovered the internet out here. And it sounds like I’m talking to you through two cans and a piece of string. That is why.

Katie Martin
Now, have you gone out there because you’re hiding from the market turmoil and you decided to buy tinned food and guns? 

Robert Armstrong
(Laughter) I just couldn’t take the pressure any more, Katie.

Katie Martin
What did you do to the markets while I was away? I mean, it all went wrong. (Laughter)

Robert Armstrong
(Laughter) I think the basic story is familiar right now. The markets fall in the United States on a Friday. On the Monday, Japan’s market starts freaking out. Everyone starts saying the phrase carry trade, carry trade, carry trade again and again, and then the whole situation starts feeding on itself and global markets fall whatever they fell, 6 per cent in very short order, and now have bounced back. But I think what readers might be wondering, Katie, is that given that this was now a couple of weeks ago, why are we still talking about this? Six per cent between friends, we bounce back. We are back where we were. What’s of interest here?

Katie Martin
I mean, you know, since I got back from my hols, it’s still the number one topic of conversation in markets. You know, everyone’s kind of looking around, you know, investors and analysts at banks or whatever, and are basically saying, what the hell just happened? Does this tell us something about how robust markets really are? They’ve kind of . . . Stock markets have been just one-way traffic higher for the longest time. And these little episodes make you think, hang on a minute, is this all just built on sand? Are we just, like, hurtling towards a disaster?

Robert Armstrong
I think that’s correct. I’m looking here at some data about the S&P 500 and half of the total gains in this bull market — there’s a much-quoted stat, but it remains true — half of the total gains in this bull market, which started back last October, are from 10 stocks. So there’s like a small number of stocks powering a huge rally. You know, the market is up more than a third, you know, over the last year. You have a few stocks that are doing it. And what’s powering those stocks up is not just earnings. It’s expansion of valuations. About half the gains are down to increases in valuation rather than increases in earnings or earnings expectations. So you have a highly concentrated, valuation-driven rally that’s gone on for a long time now. And what happened a few weeks ago makes you think, maybe this is all a little spooky.

Katie Martin
It makes you think, hmmm, can you spell bubble?

Robert Armstrong
(Laughter) Yes, exactly. You know, there’s three B’s in that, as far as I know.

Katie Martin
It feels bubbly. But, so one thing that I think is interesting and that you were writing about in your newsletter today is that we’ve had a bounceback, right? So the bond market is slightly doing its own thing. Perhaps we’ll come on to that in a little while. But stocks are pretty much back where they started. So you had for example, like, you know, one day again while I was sitting on my sun lounger enjoying myself, not thinking about markets, Japanese stocks fell 12 per cent in a day. That is a lot. But they’ve, you know, they’ve got their boots back on. Other markets are pretty much back to where they started. Now is this actually a recovery or does the flavour of bounceback not quite match the flavour of the drop, if you see what I mean?

Robert Armstrong
Yeah. So looking at risk assets in the United States, the S&P 500 is now higher than it was a month ago. Spreads over Treasuries of US corporate bonds are back to the incredibly tight levels that they were a month ago.

Katie Martin
For non-spread specialists that’s a good thing, right, in terms of it means that the valuations have come back up on those? Prices have come back up on those bonds.

Robert Armstrong
Yeah. When spreads are tight it means we’re taking risk of default in a corporate bond. You’re earning less money over what you would earn having a riskless Treasury. So a tight spread means that’s the equivalent of expensive stocks, except for bonds.

However, looking over the course of this crash, actually the stocks that have performed the best from before the whole crash started until now are actually defensive stocks. So utilities, consumer staples, healthcare; going back to the beginning of the month or the end of July, those are the stocks that have done best.

So yes, we are continuing to rally. US stocks continue to be expensive and as a group go up. But it is interesting that the stocks that are going up the most are the ones you buy if you are a little bit frightened: healthcare companies, companies that make like peanut butter and cigarettes. Hopefully that’s not the same company. And then, you know, utilities, things where demand is steady in all economic conditions.

Katie Martin
You can’t get much more stapley than cigarettes and peanut butter. (Robert laughs) These are the main food groups.

Robert Armstrong
So there is this whiff out there of risk aversion. It’s not strong enough to actually make people sell. But there’s this mild shifting of the internal composition of the market that suggests that the crash of early August had a sobering effect.

Katie Martin
I agree with you. Like, the bounceback is not exactly, you know, wha-hey, let’s go back to the party. And one thing that strikes me is that I just feel like investors were looking for an excuse to like, bake in the amazing returns they’ve had so far this year and just take a little bit of a pause.

And one of the reasons I say that is that, you know, everyone’s pointing to, ooh, it’s the unwind of the yen carry trade that’s behind this drop in US stocks. So for the uninitiated, this effectively means you’ve got super, super low interest rates in Japan. You’ve got a very, very weak yen. The idea is that there’s lots of bets that are effectively funded in very cheap yen that are pouring into US stocks, and that this is one of the reasons why US stocks have been supported. And therefore, when you start to see that unwind because the yen has suddenly popped higher, this is one of the reasons for the US stock market to fall back again.

Now, one of the problems I have with that analysis is that OK, sure, there are definitely some Japanese investors who have been using their very cheap yen and putting them to work in a super soar-away US stock market. But I feel like it’s kind of cheating to say, well, as this unwinds, this pulls the US market down. When the grand sum total of humans who ever said to me that the yen carry trade was a reason for the market to go up before this happened was zero. Literally, nobody mentioned this.

Robert Armstrong
I think that’s right. As I might have mentioned on the show before, you can never overestimate the desire of people in finance to want to say phrases that make them sound sophisticated. And one of those phrases is carry trade. And it’s also convenient to have a two-word explanation for a situation that you don’t really understand. So I think that part of it was probably over-egged.

And in fact, I think maybe the recession worry aspect of this was probably over-egged too. And your comments before got into this. Maybe we have not emphasised enough the importance of having a very crowded set of trades. Everybody was on one side of the boat. There was a little wobble and everybody ran to the other side of the boat. It wasn’t that they really thought there was gonna be a recession in the United States or that the estimate of the probability of a recession changed so much. It was, whoa, whoa, whoa, whoa, wait a second, wait a second. Because we’d all gone a little bit too far into one set of trading positions.

Katie Martin
I’m sure the bond market used to be a bit more grown-up than this. Like, it’s much more flighty. It’s much more prone to overreacting to individual bits of data than it used to be. But yeah, that has ripple effects across, you know, the whole market.

Robert Armstrong
I will say in defence of carry trade talk, there is a pretty clever guy who I spoke to recently who’s a professor at the University of California, Kevin Coldiron, who basically argues that all markets, and especially the US market, basically have the structure of a carry trade now. In other words, because so many people are trading the S&P 500 with various derivative products or levered ETFs or ways to basically borrow cheap money to bet on the S&P 500, that kind of . . . the world is a carry trade now.

And what’s important about a carry trade, of course, is that because of the borrowing structure, when it starts to go wrong you have to close your trade very, very quickly so that the world now has this structure of once you hit a certain level or speed of drawdown, it will naturally pick up speed as people are forced to sell. This is just part of life today. This is the world in markets today.

Katie Martin
Yeah. I’m tempted to go further than that even and say that it’s not all necessarily about borrowed money, right? You know, carry trade is ultimately about taking money out of somewhere where it doesn’t earn you anything exciting and putting it somewhere where you can get higher returns. And so, you know, if I open up my little kind of savings and investments thing on my phone and, you know, you can use any of these things, they’ll all give you the same results. If you say, where should I put my money today? If you’re sitting in the UK it will say, well, look, why don’t you track the S&P?

And I feel like there’s something going on from the point of view that US markets are now so huge and so globally dominant that retail investors and professional investors everywhere are all exposed to the US market. And so the minute the US market has a bit of a wobble, for whatever reason, they sell out and bring those dollars back home effectively and flip them into their home currency. So I feel like there’s a kind of feedback loop going on. You know, maybe it’s kind of exaggerated in with the Japanese yen because that’s such a weak currency and it’s got such an unusual monetary policy framework. But maybe this happens everywhere. You know, maybe there’s this kind of growing correlation between foreign currencies and the US market. That is something that we’re not quite used to yet I just think because the US swallows pretty much every investment dollar on the planet.

Robert Armstrong
Yes. I mean, at the very least you can say the S&P 500, the big American stocks, are massively owned by almost every investor in the world. So there is something, there is an asset class that everyone owns, right? And so if that asset class starts going wrong, it is a problem for every investor in the world. Every portfolio in the world in a certain sense is now connected in a way that maybe wasn’t true even 25 years ago or 20 years ago.

Katie Martin
So that’s why, you know, you get like one slightly iffy US jobs report and the whole market like, globally feels the strain from it. I think we’re just gonna have to get used to this.

So let’s kind of go back to like the first question we were asking here effectively, which is why do we still care about this summer shake-out that we had? Do you think it has left scars? Do you think there is a certain amount of caution that’s still out there?

Robert Armstrong
I think you do see that in the rates market. So if you look at just straight up Treasury rates or things like break-even inflation expectations or, you know, weird interest rate swaps or whatever, everything in those markets tells you that expectations for economic growth are now a little bit lower. And if you look at the charts, they really fell over that weekend. So something spooked rate markets in a way that it has not recovered from, right? So there is more fear embedded in the rate markets now. So that is a scar.

Another issue of course is what the market now thinks the Federal Reserve will do. But I think there we’re sort of back to the sane expectation of a single rate cut in September and maybe one or two more. So I don’t think Fed expectations are now damaged and bananas.

Katie Martin
Yeah. Maybe this is healthy, you know, that I think a certain amount of complacency, it’s set in. And you know, I think every now and then investors need a little bit of reminder that markets can actually fall so you know, hedge accordingly, reset your expectations accordingly. But you know, all things being equal, I think the rest of this year is shaping up to be much more jittery than the start. Fun times. Rob Armstrong, it keeps us in a job. I’m all in favour of market jitters from that point of view.

Robert Armstrong
(Laughter) In business. Yes. Bad markets good for Katie and Rob.

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Katie Martin
Hooray! Listen, we’re gonna wrap it up and be back in a second with Long/Short.

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All right. It’s time for Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, what you got?

Robert Armstrong
Katie, I am the kind of investor who hates gold in principle. I’m in the barbarous relic camp of gold. It’s useless. It generates no income. It’s just shiny and scarce and I don’t like that. However, if what we have said on this show is true and we are in for some sustained jitters, gold, despite basically being at an all-time high now, should be just fine for the next couple of months. So with deep regret and some hesitation, I’ve got a short-term long on gold.

Katie Martin
Wow. I haven’t picked you up on this actually, but while I was on my hols, I understand you went long bitcoin. (Laughter)

Robert Armstrong
Yeah, and it immediately crashed. It was like the words came out, I was like, long bit—. And it was like, pshaw!

Katie Martin
Someone actually texted me while I was on holiday to say, what is Rob on about?

Robert Armstrong
I mean, my justification was that the market had gone kind of bonkers and was euphoric and that the most euphoria-sensitive asset is bitcoin, so why not? But of course, having said that, the euphoria turned and headed the other direction. 

Katie Martin
Immediately. It’s impressive to see.

Robert Armstrong
Do not follow Rob Armstrong into his trades.

Katie Martin
Never ever. So I am short rightwing social media. So Donald Trump’s Truth Social — well, his Trump media and technology company, it listed like five months ago. And the stocks have hit their lowest point since then. And if you look forward to late September, former President Trump himself will start to be able to wind down some of his stake, which is worth something like $2.6bn. Not looking good for that stock. And in addition, I wrote at the weekend about why, if you want to, or how, if you want to, you can quit X, the social media platform formerly known as Twitter. I think for a lot of people, the time has come and a lot of us should cut the cord. I’ve pretty much cut the cord. 

Robert Armstrong
Katie, I’m sure if you go on Truth Social, there’s a lot of ads for gold, so our trades are actually the opposite of one another.

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Katie Martin
Yes. There you are, a nice bit of balance from the Unhedged podcast. For more balance in your ears, listen up again on Thursday. We’ll be back in your feed then.

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Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler.

FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Katie Martin. Thanks for listening.

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