πππThe market is holding its breath as we face a massive potential one-two punch this week: the fallout from Tech Meltdown Friday and the highly anticipated Bank of Japan (BoJ) meeting on December 18 to 19. All signs point to the BoJ raising its policy rate, a historic shift that could send shivers down the spine of the global financial system and unleash a wave of volatility.
How a Japan Rate Hike Affects the Carry Trade
For nearly 3 decades, investors have leveraged the yen carry trade, borrowing yen at ultra low or even negative rates and investing that cheap capital into higher yielding assets around the world. This includes US tech stocks and bonds.
A BoJ rate hike changes this equation dramatically. Why?
Borrowing becomes more expensive: The core premise of cheap yen funding disappears, reducing the attractiveness of the trade.
The yen strengthens: Higher rates typically cause the yen to appreciate, narrowing the interest rate differential with other currencies like the US dollar.
Forced unwinding of trades: As the trades become less profitable or even loss making, leveraged investors are forced to unwind their positions. This means selling off global assets such as stocks, bonds and crypto and converting the proceeds back into yen.
This unwinding process can be violent. A BoJ rate hike in August 2024 for instance, triggered massive risk aversion that saw significant drops in the markets globally.
Will the Market Be Volatile This Week?
Yes extreme volatility seems high likely. The combination of last Friday's tech sell off and the looming BoJ decision sets the stage for a turbulent week ahead:
Tech Sector Jitters: The recent broad sell off in AI stocks has left the markets fragile. Investors are nervous and quick to pull the trigger on selling to lock in profits or cut losses.
The BoJ Canary in the Coal Mine: Many analysts are calling the BoJ hike a "canary in the coal mine" for global markets. This is a potential trigger for a broad based repricing of risk.
The market is broadly pricing in a hike of 0.75% but the forward guidance from the Japanese Governor Ueda will be scrutinised for hints of further moves. This would exacerbate the unwinding.
Policy Divergence : The potential for a BoJ rate hike to coincide with expected rate cuts by other central banks creates maximum policy divergence. The transition will likely be chaotic.
Prepare for a bumpy ride this week as the markets grapple with the end of an era of easy money.
What Should Investors Do Amid The Chaos?
Be patient and do dollar cost averaging.
In the face of such intense volatility and macroeconomic shifts, many investors are left paralysed by fear. The prevailing wisdom for long term wealth building in these moments of uncertainty often centers on 2 pillars of strength : Patience and Dollar Cost Averaging (DCA).
The long term trajectory of well diversified index ETFs has historically been upward, riding the wave of economic growth.
The best index ETFs are those that are broadly diversified across the market , have very low expense ratio and track major established indices. This approach reduces the risk of trying to pick individual winning stocks and ensures that you are invested in the overall growth of the economy.
Here are some key index ETFs suitable for dollar cost averaging and why they are recommended:
1. US Total Stock Market Exposure:
$Vanguard Total Stock Market ETF(VTI)$ is highly diversified , holding stocks in nearly 4,000 US companies. It offers comprehensive market coverage and has a low expense ratio of just 0.03%. VTI is ideal for investors seeking exposure to the overall performance of the US economy.
2. US Large Cap Exposure (S&P 500):
$Vanguard S&P 500 ETF(VOO)$
3. International Stock Market Exposure:
Diversification beyond the US is crucial to capture global growth opportunities and mitigate single country risk.
$Vanguard Total International Stock ETF(VXUS)$ offers a comprehensive exposure to over 8,000 stocks in developed and emerging markets outside the US. It helps to balance a US heavy portfolio and has a low expense ratio of 0.05%.
4. Total World Stock Exposure
For the ultimate simplicity, a single ETF can cover the entire global stock market .
$Vanguard Total World Stock ETF(VT)$ invests in nearly 10,000 companies of all sizes across both US and international markets in one simple package. This makes it a powerful all in one solution for long term investors wanting instant global diversification with a single trade and a low expense ratio of just 0.06%.
Why DCA into these ETFs?
Broad Diversification: These ETFs minimise risk by spreading investments across hundreds or thousands of companies and sectors , ensuring that you are not overly reliant on any single stock's performance.
Low Costs: The ultra low expense ratios mean more of your money is invested and compounding for you over time.
Simplicity: Dollar cost averaging into these index funds removes the emotional stress of timing the market and picking stocks, letting you benefit from the long term upward trend of the global economy.
Automatic Rebalancing: By tracking market cap indices, these funds naturally rebalance as companies grow or shrink, ensuring your portfolio remains relevant to the current market landscape.
Concluding Thoughts
While the immediate future of the markets appear turbulent , fraught with the anxieties of Tech Meltdown Friday and the looming BoJ decision , the long term solution for building durable wealth remains steadfastly simple : Patience and Discipline.
Remember the profound wisdom of Warren Buffett:
"Our favourite holding period is forever"
and his partner , the late great Charlie Munger:
"The big money is not in the buying or selling but in the waiting ".
Filter out the daily noise, stick to your long term plan and let the magic of compounding in quality global ETFs do the heavy lifting.
Stay calm, stay invested and above all be patient.
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