US equity investment, hedging method to overcome high-value phobia

US shares that had kept historic highs prices falling back as a result of a rise in long-term interest rates (2.85% on 10-year US Treasury rates, closing on 2 February), nervous development .

The drop is only 4.1% from the high in January at the Dow and 3.8% at the S & P 500 as well, but it seems that it has felt a bit cold water as the steady trend without turbulence lasted long. Is it a good opportunity to buy a bargain with the beginning of a full-fledged adjustment / declining phase or a temporary small decline? No one really knows such short term expectations.

The investment attitude that depends on short-term expectations that are out of order is unstable and not rewarded in the long run. Rather, it seems that the phase of risk hedging began to arrive in a general view and reviewing the portfolio ratio of US stocks and long-term bonds.

The rise in long-term interest rates, which is the cause of current stock price declines, also provides effective hedging opportunities for future US stock declines. Consider this point including the risk hedge of the dollar exchange rate.

Effective risk hedging is possible

In terms of the US economic upswing in 2018 and corporate profit growth expectations, the stock price index (PER, based on the latest 12-month account settlement report) is 25.8 in terms of stock index S & P 500, 10-year average per-share In the Schiller PER (CAPE ratio) based on net income 33.4 (both as of February 2) has soared. The level of Schiller PER, which peaked at the peak of the IT bubble, reached a historically high 50.2 in December 1999, but the current level is the second highest.

For those who are not experienced in investment, it seems that there are not many people who think that "It would be good to sell it if it looks down at the chart etc., but if it goes down," it is difficult for those who have a long investment experience. There are many people who sell it as though the raise trend is over and lose profits from the subsequent long succession.

However, while using reasonable hedging (risk aversion) measures, it is possible to improve long-term returns while mitigating risk of declining. Indeed, it is one of such inventions that diversified investment which became obvious today, or an index investment fund itself which makes it easy to use it.

However, even with index investment (dollar basis) linked with S & P 500, there are ten declining phases when it comes down from the economic recovery period back to the year 1950 to see how the stock index fell during the economic recession period. 

Although it did not become a recession, there were two times that a decline of more than 30% occurred (1987 and 2002) (Reference column: “Consider the next US recession and the room to fall stock price " 2018 1 Monday 10). The average decline rate from these 12 most recent highs is 31.2%, the maximum decline rate is 57.7% (2007 - 09), and the minimum is 14% (1959 - 60 years).

The annual return of S & P 500 after 1950 (based on dividend reinvestment) is really high at 9.6%. However, if we cannot tolerate a decline in stock price of more than 30%, which is occurring twelve times since 1950, we cannot acquire that high return.

Moreover, next time in the US recession, the risk appreciation of the worldwide investors will likely lead to the appreciation of the yen again. Therefore, if Japanese investors invest in yen funds, considering the dollar's decline in the yen against the yen, there is a high possibility that the decline rate of the yen base of the US stock will not be about 30%.

Long-term bonds in the United States are effective in alleviating portfolio risk by making inverse correlation with US stock declines. For institutional investors who have a portfolio diversified in domestic and foreign stocks and bonds in Japan, this is aware of, but it is wisdom that has not taken root in Japanese investors why.

The chart shows the trend of market value assets in the case of holding both 50% each of both ETF (IVV) linked with S & P 500 and ETF (IEF) linked with long-term US Treasury (7 - 10 year), respectively (Both dividends · interest reinvestment, dollar basis). In the S & P 500 only portfolio, the annualized return is high at 9.8%, but it has declined by about 51% from the 2007 to 2009 bottom price.

 There are not many people who can bear with ease by reducing the value of their portfolio by half. As a result, many people are unable to make additional investment despite being a stock buyer of a thousand in stock market during the recession, in the worst case they will cease investment.

However, long-term US bond-linked ETFs have increased approximately 30% in value in nearly the same period. It is because monetary easing raised long-term bond prices (yields plummeted). As a result, in the portfolio holding 50% of both sides from the start of the ETF in July 2002, the decrease in value at the same time is relaxed to 23%.

High performance in the synthesis of US stocks and US long-term bonds

Annualized returns and risks (annualized standard deviation) of the three cases are as indicated on the chart. Risk here is the standard deviation of annualized conversion of the monthly change in asset value. For the sake of clarity, for example, the risk of 10% means that the probability of falling within the range of 10% above and below as a one year variation is about two thirds.

Investment performance is generally indicated by a Sharpe ratio that divides annual return by risk. The composite portfolio of stocks and long-term debt 50: 50 is the highest among these three, and it can be said that it is high performance. The reason is that the price of stocks and long-term bonds tends to move with an inverse correlation, so the fluctuation of the portfolio is alleviated by the amount of movement that goes against, and the risk is reduced.

However, if long-term bonds are purchased at a time when the yield is still low, the return will also reduce the hedging effect. Therefore, how much money to incorporate long-term bonds into the portfolio is the skill of hedging, as monetary policy is tightened in the latter stage of the economic recovery and yields of long-term bonds are as high as possible?

In my own experience, when the ten-year US Treasury yield was more than 5% in the autumn of 2006, we held 10-year zero coupon bonds with US shares (S & P 500 ETF) at a ratio of 6: 4 60%), so we were able to ease the valuation loss on shares at the time of Lehman shock.

Even against the sharp appreciation of the yen and the dollar at that time, we maintained a 90% hedge rate at the dollar selling holding of FX trades, so we did not get shaken. After the bond became maturity redemption, the US long-term bond yield was judged to be too low and he did not possess it. However, from the level of around 3% on the 10-year yield, I will try to split up and start buying again.

However, when you purchase in-kind bonds, the time to redemption becomes shorter with the passage of time. As a result, price fluctuations for a 1% yield change gradually become smaller, so you have to replace them yourself. In that respect, "iShares Core US Treasury 7 - 10 Year ETF (1656)" listed on the TSE since last year will be replaced by the fund operator so that it operates in 7 - 10 years, so here it looks good to buy.

How far will the 10-year US Treasury yield go up by the next recession? Perhaps it is at most 3% to 4%. Although not as much as Japan, the US economy has also experienced a structural change after the Lehman shock, and there is a strong tendency not to raise inflation rate and wage growth rate. 

Even with the economic upsides expected from this year to next year, the probability that the 10-year US Treasury yield will rise to around 5%, which is the peak before the Lehman shock, will be very low.

Why is the appreciation of the yen despite expansion of interest differential between Japan and the US>?

The hedge of foreign exchange loss arising in the yen appreciation and the dollar depreciation that will occur again in the recession of the United States is a major factor affecting investment performance as a Japanese investor. 

First of all, despite expectations for the upswing in the US economy after the establishment of a tranche of the cards in January this year and the accompanying rise in the long-term interest rate of the dollar (expansion of the difference in the US and US interest rates), the yen appreciation up to the 108 yen level advanced How do you understand paradoxical circumstances?

It seems that there are many people who are twisting their heads, but the extent to which macro new variables, macroeconomic variables in economic and monetary terms influence the market will depend on the gradual inclination of market participants at that time considering that it depends, it is not so strange.

For example, when the market participants' gross domestic expectation of yen depreciation is large and the yen has declined to the yen selling holding, and the yen also depressed, the news suggesting a fall in the yen and the change in economic and financial 

Even if it happens, the yen's value will often not decline so much. Rather, it is even possible for the yen to rise due to the rewinding of existing holdings. On the contrary, after the yen appreciates, if similar yen depreciation occurs, the market responds sensitively and a sharp depreciation of the yen occurs.

Let's rewind a little time and look back. Early in 2016, even after three years from the start of avionics, the rate of increase in consumer prices did not reach 2% of the policy target, even it was even lower than the same month the previous year. 

As a result, the yen's appreciation rapidly jumped from 120 dollars per dollar to 99 thousand yen due to the shift to Japanese yen price hike = yen buying holding, existing handover of yen selling holdings maintained by hope of yen depreciation Progressed.

The introduction of the negative interest rate announced in January 2016 by the BOJ did not bring about a weaker yen effect. This is probably because the existing holdings of market participants are inclined to yen selling overall, losing confidence in sustaining its yen selling holdings, and rewinding the yen (yen buying back) process.

Thereafter, from the time immediately before the US presidential election in November 2016, if the winner of the cards won, a large tax cut of his pledge and investment of massive infrastructure will occur, the US economy will rise, the long-term interest rate will rise as well Market participants began thinking seriously. 

And with Mr. Trump’s victory, the long - term interest rate appreciated at a stretch, the dollar appreciated and the yen weakened. (Reference column: "The trump market is still a prologue, the shock of a large tax cut " November 21, 2016)

The point to note here is that the long-term interest rate differential between Japan and the US and the change in the dollar exchange rate were almost uncorrelated until the summer of 2016. 

However, since the beginning of 2016, the existing holdings of market participants have already turned to yen buying, and the yen has appreciated. As a result, there was a hypersensitive response to the financial situation change unfavorable to the yen buying position of expansion of the difference between the US and the US interest rates, which was the rewinding of the yen buying holding, that is, yen selling, and in December of the same year the yen's depreciation Progressed.

Of course, there is no real-time data showing the gradient of the overall market exchange in the market, for example non-commercial muscle futures of Chicago IMM represents the slope of exchange gains around the world as "a corner of the iceberg" It is considered to be. What I have stated is consistent with the change in the Chicago IMM's holdings.

<Hedging to the depreciation of the yen against the dollar in the medium term is indispensable>

Considering this, I can understand the fact that the yen appreciated instead of the depreciated yen despite the rise in long-term interest rates in the US dollar in January (expansion of Japan-US interest spread disparity) as follows.

That is, with the rapid progress of the euro / dollar depreciation, in which the existing participants' existing holdings tend to be quite yen-selling, and the Eurozone’s economic boom improved, the market participants bought dollars against the yen I was losing confidence in sustaining high. 

As a result, the dollar long-term interest rate rise did not cause new dollar buying and yen selling, and on the contrary, the rewinding of existing yen selling holdings (yen buying) occurred.

Although there are comments emphasizing the possibility of the BOJ's policy change as a reason for the movement towards the yen's appreciation, it is only a truly weak yen-high material compared to the dollar long-term interest rate that actually progressed. 

In short, when existing holdings tilt in one direction, and market participants are beginning to feel uneasy about their continuation, it is only that there is a hypersensitive market reaction of "waterfowl feathers are also so-called enemy attacks".

The medium-term stance on my dollar exchange rate has not changed from the September column last September column "The yen appreciation suggested by the real dollar exchange rate " (September 12, 2017). 

Looking at the dollar exchange rate since 1973, there are 6 mountains of the dollar (yen weak) with the real exchange rate greatly deviating from the tipping average, 5 times the valley of the dollar weak (yen appreciation) Have judged that the final phase of the wave of the sixth dollar high is starting.

In the next recession of the United States again, the yen appreciation of 90 yen per dollar, 80 yen level would be a natural result. However, as I wrote in the column in January, there is still more than a year before the next recession in the US begins, so there is still room for a rise in US 10-year government bond yields, 

The possibility of high · dollar depreciation will still be low. Therefore, for investors who are not able to hedge against yen / dollar depreciation due to futures reservations or FX trades, perhaps one year or so may be the last chance of hedging dollar selling.