The ongoing S&P 500 bull market is facing a major risk, but contrary to popular belief, it’s not due to a potential US recession. According to strategists from BCA Research, the real concern lies in Japan’s sharply negative real interest rates in comparison to the United States.
In a recent report, BCA highlighted that Japan’s real policy interest rate differential with the US has reached an unprecedented -5.4%, a figure deemed unsustainable. Since 2022, Japan’s real interest rate gap with the US has widened by 12 percentage points, a shift BCA views as a key driver behind the inflation seen in US tech stock valuations, particularly in the artificial intelligence (AI) sector.
This decoupling of tech stock valuations from US bond prices began in 2022, at the same time Japan’s real rates plunged. Now, tech stocks are inversely correlated with the Japanese yen, which has weakened due to Japan’s deep negative real rates. BCA believes that borrowing in yen at these low rates has been a significant factor in inflating US tech stock prices.
The surge in tech stocks was further fueled by the release of ChatGPT-4 in March 2023. However, BCA suggests that this spike wasn’t purely due to AI excitement but rather the result of yen-based borrowing at negative rates.
Despite strong sales and profit growth for companies like Nvidia (NASDAQ: NVDA), BCA warns that the true profits from AI have yet to materialize, and it’s uncertain when or if they will.
A warning signal appeared in July 2024, when tech stocks saw a sharp decline. This correction came amid speculation that the Bank of Japan (BoJ) might abandon its zero-interest rate policy (ZIRP), which was followed by a rate hike on July 31, 2024. At the same time, weak US job data fueled expectations of US Federal Reserve rate cuts, which helped reverse Japan’s real rate differential with the US, contributing to losses in US tech stocks.
BCA suggests that a stronger yen, alongside rising interest rates in Japan, could deflate the high valuations of US tech stocks, as seen during the market correction in mid-2024. They also recommend holding a long position in the Japanese yen as a hedge against potential weakness in US tech stocks, given the inverse correlation between the yen and tech valuations.
Alternatively, the collapse of AI hype could lead to an unwinding of yen funded investments in US tech, further strengthening the yen and weighing on tech stock prices.
