There has long been a strong correlation between the Nikkei and the US Dollar/Yen.  A similar version of this correlation is that of the Nikkei and US interest rates.  The thinking is rather simple.  As a trade surplus nation the rising Yen puts downward pressure on profits and Japanese equities.  Unfortunately, the calls for a bottom in the USD/Yen have been made for years on end.  But Credit Agricole thinks the time could be now and that that’s bullish for Japanese equities,  This argument would be reinforced if one believes interest rates in the USA are bottoming (which, if you take the Fed’s 2014 forecast seriously means Credit Agricole might be right in the short-term, but is wrong in the longer-term):

“Our argument is different. If the story of the rebalancing of growth – with an inflationary bias – within the global US$ area is as powerful as we suspect then the greatest potential beneficiaries should be ultimately the most distressed parts of the world equity landscape. The world’s cheapest major equity zone is the euro area – and Japan.

It is time to reassess Japan, once again. The Bank of Japan has just announced an unexpected supplement of quantitative easing of a rather more authentic kind than that practised by the ECB. But nobody seems excited, because it’s Japan, and everybody thinks that it has all been attempted before without success.* However, the context has become more favourable to the Japanese stock market: policy relaxation in the emerging world, a more stable US$ and improved expectations for global growth.

The point is that there is a tangible catalyst for the revival of Japanese equities: the exchange rate. If the “end of reflation” in America really does imply a more stable US currency then, sooner or later, the downward trend in US$/Yen will reverse. We suspect that this is what we are witnessing. We will have the confirmation when the US$ trades above Yen 81/82.”

I don’t know if I agree there.  For years now I have discussed the fact that Japan is encountering a demographic trend that is highly problematic.  That makes the macro trends in their economy extremely difficult to feel bullish about.  I say stay out of Japan and focus on other markets.  The Nikkei is like dealing with a penny stock in a world of high quality options.  If you want to gamble you’re better off in Vegas where the drinks are free while you flip coins.

Source: Credit Agricole


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • B Ferro

    Better way to look at this might be the ratio of the DJ Global Stock index vs. the Nikkei – the ratio has traded in an upward trending channel for over a decade (global stocks outperforming the Nikkei) and the ratio sits at the top of the trend line and is just beginning to break down. In other words, the Nikkei is set to outperform in a solid way moving forward.

    SNE, PC, etc.

  • Optimist

    It seems to me that most Japanese exports are not currency sensitive – they’re mostly products with relatively little competition. I cannot see Japan getting an export-lead recovery because the Yen falls a little against the US dollar. I don’t see investors rushing to buy Japanese investments because they’re a bit cheaper either. I admit to having less expertise than the author – but I need a bit more convincing.

  • Alberto

    The smart hedge fund manager Hugh Hendry has quite a different opinion. An interesting reading:

  • JBacon

    Someone please correct me if this line of reasoning is incorrect, im no economist: Japan has ~200% debt/GDP, mostly held by banks, pension funds, and other domestic institutions in the form of JGBs. As noted in the article, a couple of weeks ago the JOB stated it would begin QE in conjunction with inflation targeting. With the Yen at record strength vs. USD, at some point doesnt the BOJ need to seriously devalue the Yen in order to stay solvent. And if so, isnt this bullish for Japanese equities as investors, especially Japanese holders of JGB, look for inflation protection and anything with yield. comment appreciated, thanks

  • B Ferro

    Exactly JBacon – here’s how I think it works for Japanese equities…

    What has the past decade been about? A global, commodity/infrastructre-driven EM inflationary wave.

    Guess who suffers the most in that environment? Anybody, or any company, suffering from an inherently deflationary economic environment or price structure, right?

    Well, guess what country suffers from that the most globally? Japan! What industry? Tech of course, as it is inherently a deflationary industry (every year more innovation but at a cheaper price!!).

    What happens if that decade long inflationary wave reverses? Who benefits the most? You guessed it, Japan and tech. Even better, Japanese tech!

    I truly believe the commodity wave of the past decade is over. Look at how coal and steel stocks are breaking down. Now, gold and silver might be their own panacea going forward given their fundamental stories are less about EM infrastructure build out and more about global debt issues, but the core inflationary commodities you pull out of the earth are most likely past the peak of their growth trajectory and now on the downside…

    And what matters most to investing returns? Not the absolute rate of growth, but the marginal change in that growth. As such, commodities get smoked if growth in China, for instance, slows only marginally from 9% a year to let’s say 5%…in effect, you don’t need a hard landing in China for commodities to get smoked!

  • Mr. Market

    I need to correct my previous comment somewhat. From the early 1990s up to now Japan had the lowest short term rates and that was the/a MAJOR reason the Yen carry trade emerged. When all leveraged trades blew up in 2008 the Yen went up against e.g. the Euro.

    After 2008 US short term rates were at rock bottom low. So, IMO the USD became a carry trade currency as well. So, I would expect that in the next leg down in the markets both the USD and the Yen will/could go up together against the same Euro. That would signal that both the USD and Yen carry trade are unwound.

    Buy japanese stocks ? No thanks !

  • Erik

    Cullen, would you really be buying stocks in a country where both major political parties agree that taxes must be raised in spite of the fact the country is in recession? A country whose politicians have no understanding of the modern monetary system as they fret about their debt/gdp ratio?

    The yen may indeed fall, but it will be because a rising dollar means a weakening economy here, hence less import demand for Japanese products.

  • Cullen Roche

    I am not buying Japanese equities….

  • slightly_skeptical

    How many more Olympus’s are there in Japan waiting to implode? I get the impression this is just the tip of the iceberg and with a receding water line will expose itself further – Consider: 1. Japan is no longer and net exporter, 2. its aging population demographics, 3. 200+% debt to GDP. Twenty odd years of Japan’s easy monetary & 10% GDP deficit spending policies to cover up their burst bubble from the 1980’s have a tendency to create companies addicted to them – what happens when the easy money and deficit spending can no longer be sustained?