UPSIDE BREAKOUT IN JAPANESE STOCKS ADDS TO BULLISH ENTHUSIASM FOR STOCKS AND COMMODITIES -- A WEAKER YEN AND STRONGER AUSSIE DOLLAR IS ALSO A GOOD SIGN FOR RISKIER ASSETS
JAPAN ISHARES HIT FOUR-MONTH HIGH ... Global stocks and commodities are continuing the strong rally that started last week. One of the reasons being given for today's U.S. stock rally is better employment news and strong retail sales. The fact that foreign stocks were already rallying before release of today's U.S. reports suggests that there's a strong global element as well. One of the overlooked reasons for that growing optimism may be an upturn in Japanese stocks. The tsunami and earthquake in that country during March caused Japanese stocks to tumble 20% as shown in Chart 1. That caused selling in most other stock markets which have essentially been moving sideways since then. If you compare the EWJ to the S&P 500 (below chart), you'll see a correlation between the peaks and troughs over the last four months. Economists have also suggested that the shock to the Japanese economy has weighed on the global economy. The good news is that the EWJ appears to be breaking out of that four-month basing pattern. That may be one of the reasons for the sudden burst of optimism in global stocks and commodities and the willingness of global investors to move into riskier assets which includes foreign currencies. One of the "safe haven" currencies being sold, however, is the Japanese yen. The orange line on top of Chart 1 shows the yen starting to weaken over the last month. Since the Japanese market is so export-oriented, a weaker yen gives a added boost to Japanese stocks. The weaker yen may also be a positive sign for global stocks and commodities.
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Chart 1
AUSSIE DOLLAR STRENGTH/YEN WEAKNESS SIGNALS RISK-ON... Chart 3 compares the relative performance of the yen (orange line) and Australian Dollar (blue line) since the start of 2011. In general, the yen is considered to be a "safe haven" currency. The Aussie Dollar, by contrast, is one of the world's higher-yielding currencies and is usually bought when global traders are more optimistic about global stocks and commodities. The fact that the XAD is also a "commodity currency" ties it more closely to the trend of commodities. After the March tsunami, for example, the yen jumped sharply as the Aussie Dollar tumbled. The XAD recovered after the yen peaked. Over the last month, the XAD has started to rally as the yen has weakened. Chart 5 makes it easier to compare the two currencies. The blue line in Chart 5 is a relative strength ratio of the Aussie Dollar divided by the yen. The blue ratio line shows the XAD turning up relative to the yen over the last two weeks after two months of underperformance. If you compare the trend of the blue ratio line to commodities (top of chart) and stocks (bottom line), you can see that they generally rise and fall together. In other words, the close correlation between the three lines suggests that stocks and commodities usually do better when the Aussie Dollar is doing better than the yen (as it is now). The rising Aussie Dollar and weaker yen signal that after two months of playing defense, the "risk-on" trade is back.
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Chart 2
