After a perfect year in 2017 (with the S&P 500 up every single month), equity markets are struggling.
The S&P 500 just finished down 2 months in a row (February, March) for the first time since early 2016. Meanwhile, the Japanese yen is rising, leading all major currencies against the dollar in 2018. Are these facts related? Can investors count on the yen acting as a safe haven during times of equity market stress? Let's take a look.
Data Source for all charts/tables herein: StockCharts.com (Philadelphia Yen Index, S&P 500 Price Returns)
With data on the Japanese yen going back to 1977 (Philadelphia Yen Index), we find the following:
- The yen has been positive 52% of the time during down months for the S&P 500. In the worst monthly declines for the S&P 500 (<-5%), the odds of a positive yen increases slightly, moving up to 55%.
- From a return standpoint, the yen has performed better in down equity months than up months (+5.0% annualized versus +0.6%) and better still during the worst down months (+9.2% annualized versus +5.0%).
- During the 15 worst down months since 1977, the yen was positive 11 times (73.33%) with an average return of +1.6%.
- During the largest equity market drawdowns, the currency has had mixed results. In the 2007-09 bear market, it performed admirably, gaining 18%. But in the prior bear market (2000-02), the yen declined 12.8%.
Why the disparate performance? The yen's status as a safe haven has varied considerably over time, becoming more pronounced in recent years (post 2005).
This is a by-product of the currency's oscillating correlation with the S&P 500. The yen has at times moved in the same direction as the S&P 500 and at other times in opposite directions:
- In the 3-year period leading up to August 2001, the correlation between the yen and the S&P 500 hit an all-time high (0.46).
- In the 3-year period leading up to October 2008, the correlation between the yen and the S&P 500 hit an all-time low (-0.66).
So is the Yen a Reliable Safe Haven?
That depends on your definition of "reliable" and whether you consider recent history to be of greater significance than the overall record. Over the full data set going back to 1977, the yen's record as a safe haven is only a little better than a coin flip (52% positive during down S&P 500 months). In recent years, though, that record has improved (63% positive since 2006), particularly during the most extreme down periods (79% positive in months with 3% loss or greater since 2006).
The real question, then, is whether something has fundamentally changed in recent years to warrant an expectation of this inverse relationship continuing. Have the reasons posited for the yen's safe haven status become more compelling (see Appendix A below)?
They certainly appear to be, with Japan's net foreign assets increasing significantly (+93% from 2005-2016) and the Bank of Japan implementing negative interest rate policy. But will they continue to be? I don't know, but the yen's reliability as a safe haven depends on it.
Appendix A: Reasons Posited for Yen's Safe Haven Status
1. Repatriation of foreign assets. Japan's significant balance of net foreign assets (349 trillion yen at the end of 2016) puts it in a unique position. During time of equity market stress, Japanese investors tend to bring money back home, causing the currency to appreciate as the foreign currency is converted back to yen.
Data Source: Ministry of Finance (Japan)
2. Unwinding of the Carry Trade. Japan's interest rates are among the lowest in the world, with a central bank rate of -0.1%. In the "carry trade," investors borrow from low interest rate countries like Japan and invest in higher-yielding/return assets abroad. During times of stress, investors are more apt to pay back these loans, converting back to yen and driving the currency higher.