The unwinding of the decade-long yen carry trade highlights how the interconnectedness of the magnificent six’s revenue and earnings, and the concentration into these names due to the popularity of market capitalisation-weighted indices, can lead to outsized risk in client portfolios that warrants examination, Cathie Wood of Ark Invest has said.
The magnificent six excludes Tesla and includes Microsoft, Apple, Facebook parent Meta, Amazon, Google parent Alphabet and Nvidia.
Wood, chief investment officer at Ark Invest, explained that over the past decade investors had benefited from using Japan’s low, or even negative, interest rate environment to execute a carry trade – that is, to borrow or 'short' – the Japanese yen or government bonds in favour of reinvesting that capital in other areas with higher yield and/or potential reward, such as US Treasuries.
According to industry estimates, as much as $20tn (£15.3tn) may have been directly or indirectly allocated to this carry trade, which is roughly 15 per cent of the global equity market capitalisation.
On July 31, The Bank of Japan raised its key interest rate to about 0.25 per cent from a range of zero to 0.1 per cent, perhaps to curb the yen’s depreciation against the US dollar.
The central bank also added it would reduce the monthly bond-buying to ¥3tn (£15.7bn) in January-March 2026 from the current pace of around ¥6tn to pursue a more normal monetary policy.
Wood said while the US Federal Reserve kept rates unchanged in July, market participants appeared to have begun unwinding this carry trade, perhaps out of necessity (ie margin calls).
As a result, the markets "reverberated violently", and it appears that unsuspected areas of the financial markets, namely broad indices highly concentrated into the magnificent six, may have been buoyed up by this leverage, creating a liquidity spiral as forced sellers unwound this carry trade.
Wood pointed to the unwinding of the carry trade as one of the drivers of recent widespread market turbulence, along with a US economy that looks to be weakening and a Fed that is hesitant to cut rates, despite multiple warning signals.
She added: "Importantly, the mega-cap tech names that steer common benchmarks have shown genuine vulnerability.
"As US statistics like employment and the PMI have disappointed expectations, and at the same time the BoJ has raised interest rates more than expected, investors and speculators may have faced margin calls forcing them to unwind the yen carry trade.
"It appears that significant capital from the yen carry trade had been used to pile into mega-cap stocks, which may now be experiencing a correction in light of these macro developments. We encourage investors to reassess portfolio concentration risk and consider ways to diversify exposure.
"While these types of sell-offs are sparked by market fear and risks to consensus positions, they often create pockets of opportunity. Historically, these condensed bouts of volatility lead to a market rotation that can favour a broadening out away from the contributors of this volatility.
"In our view, though disruptive innovation may be susceptible to volatility in this climate given its relatively high beta nature and the unknown length of this market shock, it may benefit from a resultant, more receptive Fed, a general broadening out away from the prior consensus, and a light being shed on the shift of inflation to disinflation."
