Why Japan's Financial Crisis Could Destroy US Stocks

I've actually been looking at taking a trip to Japan, but I think for the reasons that will become apparent in this video, that's going to become a whole lot more expensive. And it got me thinking about the knock-on effects for us as investors, because even if you think, well, James, I'm not investing in bloody Japan, I think there'll be big implications for us all. So in this video, I'll explain exactly what's going on, how to position for this, and along the way, I'll be showing you the tools that I've built over my career in markets as a pro that have enabled me to build my own portfolio now to over £2 million. So all the stories are talking about the central bank increasing rates once again as the yen has reached a multi-decade low. And part of the reason for this urgency is inflation. But when we look at the chart of inflation, you can see here it's up at 1.7%. It's not even 2%. But for Japan, this is a big deal. Going back to the early '90s, We've seen deflation, in fact. So this is where the interest rate is at. The base rate is now 1%. And again, you might think, whoop-de-doo, you know, that doesn't sound like a lot. Well, the fact of the matter is that rates were negative as recently as 2024, a couple of years ago, and they've been held there for God knows how long. When we pull up a longer-term chart of the interest rate, this will put it in better perspective. So you can see here it shot through the roof on a really short timeframe. But zooming out, we had all the cuts when Japan realized that it was screwed, and then rates were held at zero and even went negative. The impact that this had on the yen, perhaps not surprisingly, so this is the dollar buys a number of yen. The yen has been weakening. Inflation is now at 1.7%. And interest rates are at 1%. And that means that your cash is losing purchasing power even after interest. And that means currency weakness. So with even more inflation, this is looking like a case of, well, we can't hike fast enough and they must defend the currency. It is super duper weak, which is brilliant. Again, if you are going there to live for a month or two, But for Japanese policy, it's a big problem. So that's the first domino to drop. So the, where this comes into the markets and the bigger picture is that there's something known as the carry trade. Now don't get lost in this. I'll break it down. All this is, is a strategy that many hedge funds employed. It's very commonplace amongst the pros. And it just sees you basically buy the currency that has the relatively higher interest rate. Now, in the case of Japan, on the global scene, they've for decades had the opposite of that, the relatively lowest interest rate, which meant that they were always the funding currency on the other side of it. So you want to buy the one with the relatively high interest rate, which historically might have been, say, the Australian dollar, maybe the US dollar, and sell the Japanese yen. So that's what's turbocharged yen weakness and this rally in dollar-yen over the past 15 years. And all of this now is beginning to potentially reverse. Japan's interest rates are expected to continue rising. And that means that it doesn't look as attractive on a relative basis against those other high-yielding currencies that the funds are now looking to get out of. So they're going to exit this trade. Let me show you with a chart here, which should make it a little bit more clear. So if we compare again Japan's interest rates and also add Fed funds, the US in blue has of course had a higher interest rate than Japan. So if you plot the difference between the two so that we can see the change, there's actually convergence here. The US rate is going down and Japan's rate, as we've mentioned, is going up. So if we go to plot the difference between US interest rates less Japan's interest rates, which remember is the basis of the carry trade, you earn the difference in, in the interest rate. For just holding it with theoretically no risk, you can see that that's heading lower. So this is the reason why many people are looking to get out of the carry trade. So hopefully you're still with me. You've got Japan having to raise interest rates from record lows whilst central banks, including the US, are actually beginning to cut rates, or at least have been cutting rates. And that gap between the two, the differential has been narrowing. Which has made the carry trade less profitable. So what happens next is that that all unwinds, meaning that funds now who were historically short yen have to buy back yen. And in order to do so, they need to raise money in dollars, which means they have to sell US assets to get some dollars. To buy back yen. Now, if you remember the dominoes from earlier, this has real consequences, not only for the global economy, but for many other things that might be in your portfolio. And if you're not aware of the correlations, then frankly, you're sleepwalking into the risks. So let me show you exactly what I mean and how we should adapt so that we're not on the wrong end of this butterfly effect beginning in the Land of the Rising Sun. So this tool is probably the best way to visualize the relationship between the two and why the yen Impacts Gold. There's a link to this along with the other tools as I've mentioned in the description if you want to try them out. It's completely free for 7 days. And what we're looking at— think of this as like a clock. The yen and gold are both in the same quadrant at the same time. They're improving currently. And the line that you can see with these weekly intervals has tended to follow the same path. And that's because the two are positively correlated. There were weeks ago, if we go back to March, they were both leading and now having been lagging, they've been improving and they could be about to cross back over into leadership at the same time. So if we pull up a chart, gold of course went on an incredible run but has also seen a pretty spectacular sell-off recently too. It's down at a 38% Fibonacci retracement level around 4000. That's a big psychological level as well. 4000 is a round number. Considering what's going on here with the yen and gold being positively correlated with that is something to keep an eye on. But what about the dollar side of the trade? Remember guys, everybody had bought dollars to sell the yen and now that's reversing. We're going to be selling dollars. How are the funds going to raise that money and what does it mean for your portfolio? Let me show you here. If we take a look at the AOR ETF, this is like a 60/40 ETF. You can see this has been going sideways. There could be pressure simultaneously on the likes of IEF, which is selling off again because there's expectation of higher inflation. Bonds hate inflation. And also the S&P. There's not only war going on, potential AI bubble, but on top of it, there's this Japan event as well. So this is another reason to be really careful about what you own, even if it's outside of Japan and you think it's safe in, say, the US. When stocks and bonds are falling, you've got to find shelter somewhere else. And commodities are usually the area of the market that performs well when there's also inflation. But there's more to it than just buying gold. And when you see what's actually going on beneath the surface, you could be missing the best returns if hedge funds are maybe rotating into things like energy or base metals like copper, even wheat, soybeans, etc. So let's see where the money's heading right now so that you can hopefully find better setups over otherwise just putting your money in gold, which is so consensus. It's just returning back to the rotation tool again, we can click into commodities. Now we can see that crude oil, having begun to lag the market a few weeks ago, cycled back up into leadership as there's been that break in the ceasefire recently. Just pull up a chart to make it clearer here. You've no doubt felt it at the pump, but that's the, the move. It's been incredibly volatile, and that's what this is representing. So there's seemingly some leadership in energy rather than precious metals or base metals at the moment. So it might not be a case of defaulting to, okay, I'll buy gold, like the consensus, or okay, well, if it's not gold, then what's the next metal? Copper. In fact, it looks like energy might be the place to be. But what about some of the agricultural commodities? Let's put wheat, corn, soybeans on here. They all seem to be clustered around the center, so there's not a great deal happening. They don't look to be the answer here. So perhaps looking to energy is the better sector within commodities to perhaps be looking for ideas in. There's an ETF if you don't want to invest specifically in crude oil, DBE, for example. None of these are course recommendations. I'm just giving you some ideas off the top of my head. DBB is the base metals, so that would be the likes of copper, which as we've seen are underperforming. And then DBP, I believe, is the precious metals one, gold, silver, and so on. And that looks, not surprisingly given its weighting to gold, pretty much like the gold chart. So hopefully you can see now how just following the consensus and crowding into the first trade, which should be gold given its positive correlation, might not be the right move. Sure, it's correlated to the yen, but as US assets are sold and the dollar weakens, that then has a much broader impact on commodities generally. So there's more to play for, perhaps more opportunities here. So hopefully you found that useful, guys, and it's answered some questions about how What's happening in Japan when a butterfly flaps its wings, or in this case, the Prime Minister decides to hike rates, can have a knock-on effect globally and for your portfolio, even if you're not invested in Japan. So if you've enjoyed this video, then watch this one next, which YouTube thinks you're really gonna love. And if you don't, then send me an email and I'll give you a full refund, just not in yen, because I think it's gonna cost me a bit. Sayonara.