🎙️ Left Behind

The U.S. produced more crude oil last year than any other nation at any other time.

😅 That’s according to the U.S. Energy Information Administration (EIA), which says the U.S. produced 12.9 million barrels of oil daily.

The U.S., Saudi Arabia, and Russia account for ~40% of global oil production, and those three nations have led the way every year since 1971.

The average price of a gallon of gas that year? $0.36.

— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• Betting big against Japanese government bonds

• The physics wiz who made a fortune

This, and more, in just 5 minutes to read.

Chart of the Day

In The News

🎲 Betting Big Against Japanese Government Bonds

Japan has never been afraid to do its own thing—it comes with the territory when you’re an island nation with cultural roots dating back well over a millennium and a mostly homogenous population.

• But being an economic outcast in today’s deeply interconnected world stands out more than in the past.

Left behind: While the Western world has hiked interest rates in response to a pandemic-era inflation burst, the planet’s third-biggest economy has seemingly missed the memo, keeping interest rates extremely low — Japanese government bonds maturing in 10 years pay meager yields just shy of 0.8%.

In response, the Japanese yen has struggled since 2020, losing about 37% of its exchange value with the dollar (currencies’ exchange values are largely driven by interest rates).

• That translates into a huge loss for Japanese citizens’ purchasing power while suddenly making a trip to Tokyo much more affordable for American tourists.

Follow the money: Meanwhile, some big investors are betting Japan will finally undo its love affair with cheap credit, raising interest rates as soon as next week.

If interest rates move higher at the Bank of Japan’s direction, then Japanese government bonds issued in recent years (offering low-interest yields) will lose value, as investors would rather purchase freshly-issued bonds offering higher interest rates.

• Thus, a chance to “go short” Japanese bonds is becoming a popular bet. For RBC Bluebay Asset Management, selling Japanese government bonds (JGBs) before expected rate hikes is among its highest-conviction trades.
  

• The fund, which oversees over $114 billion in assets on behalf of the Royal Bank of Canada, says shorting JGBs offers “the best risk-rewards” with respect to its other macroeconomic trades.

Why it matters:

Wage-price cycle: As inflation finally ticks up in Japan, a country notorious for lacking it, RBC Bluebay is confident Japan’s central bank will respond with the usual playbook — higher interest rates.

For evidence that inflation is becoming more entrenched in Japan, investors noticed on Wednesday that major Japanese corporations were agreeing to higher salary increases for workers.

• Specifically, Toyota, which is part of a web of auto suppliers and manufacturers employing more than 5 million people across Japan, met its labor union’s wage-hike demands in full for the fourth consecutive year, signaling a “sustainable wage-price cycle may be taking hold in Japan’s economy,” according to Bloomberg.
  

• Honda has also agreed to raise worker pay by 5.6%, Mazda will raise theirs by 6.8%, and Nissan will raise pay by 5%.
  

• An uptick in wages is welcome news to the Japanese economy, which hasn’t seen meaningful and reliable pay increases since the early ‘90s. However, a cycle of higher wages is inflationary, hence the need to proactively raise interest rates.

Read more

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🌎 The Physics Wiz Who Made a Fortune Betting on Nature

Meet John Seo, a physics wiz who used scientific knowledge to create a formula to trade something called catastrophe bonds. The formula for investing in so-called “cat bonds” was the hedge fund industry’s most profitable strategy in 2023, delivering a 20% return vs. the industry average of 8%. 

Seo’s Fermat Capital Management, based in Connecticut, used its $10 billion portfolio to capture ~25% of the cat bond market.

Say what? The cat bond industry has boomed thanks to two major storylines: climate change and inflation. By nearly all accounts, neither is a good thing. 

• Yet Seo found a way to profit off both by owning the world’s biggest collection of cat bonds, complex financial instruments that insurers issue to cover risks they can’t handle.
  

• Seo and his team make decisions on complex weather-risk computer models run by large servers. He’s been doing so for two decades, and his persistence has paid off as heat waves, hurricanes, and wildfires become increasingly common. 

Storms + inflation: Because insurers issued a record $16 billion of cat bonds last year — fearful of destructive fires, stormes, and floods — people like Seo stood to benefit. Meanwhile, inflation has made rebuilding areas damaged by disasters much more expensive. 

• Americans keep buying expensive homes in places like Florida and California, areas more prone to storms and wildfires. That’s driven away some insurance providers: Less than 30% of 2023’s $380 billion in global climate losses were covered by insurance.
  

• Meanwhile, the World Bank — which issues cat bonds to developing nations — aims to increase its outstanding debt to $5 billion from $1 billion over the next five years. “We’ve very ambitious,” said a World Bank cat-bond lead. 

Why it matters:

With cat bands, investors can bet on nature. Specifically, changing weather patterns and warmer temperatures. 

Disaster strikes: Simply, cat bond investors can bet on a disaster occurring. If it does, their money can be utilized to settle insurance claims, which are rapidly rising due to inflation. 

The strategy was once reserved for only rare events that caused billions in damages, such as Hurricane Katrina in August 2005. But smaller, still powerful storms are occurring at a higher frequency on a warming planet, giving investors like Seo more opportunities to pounce.

• “The insurance market is on edge,” Seo told Bloomberg. “It’s freaked out about risk and wants as little as possible.”

Read more

More Headlines

📲 TikTok appears to be building an Instagram-style photo app. Meanwhile, TikTokers are revolting over a potential ban

🗣️ Citadel’s Ken Griffin explains why the Fed shouldn’t cut rates too quickly

🛩️ As Boeing production stalls, Southwest Airlines, which relies entirely on Boeing, cuts capacity and re-evaluates 2024 financial forecast

💸 Tax season is underway. Here are some tips for navigating it.

🛒 Dollar Tree to close down 1,000 Family Dollar stores

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Quick Poll

Yesterday, we asked: I’m [blank] concerned about market breadth and Big Tech’s concentration in stock indexes.

— Said one reader, “Big tech will always be the strongest sector long term. My policy is to buy the best stocks in the best sector, plus having XLK etf as a major holding.”

— Commented another, “Market breadth is usually one of the first indicators of a potential downturn in stock indices. This is reflected in the change in direction of the advance-decline line.”

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See you next time!

That's it for today on We Study Markets!

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