JAPANESE STOCKS ARE GETTING A BOOST FROM A FALLING YEN -- JAPANESE STOCKS AND THE YEN ARE NEGATIVELY CORRELATED -- EMERGING MARKET ISHARES ARE RISING ALONG WITH EMERGING CURRENCIES AND ARE OUTPERFORMING THE U.S.
FALLING YEN BOOSTS JAPANESE STOCKS ... Foreign markets generally do better when their currencies are rising. That's been the case with Europe over the past few months. It's also been true in emerging markets which have been rising along with their currencies. One major exception to that rule in foreign stock markets is Japan. By contrast with other foreign markets, Japanese stocks thrive on a falling yen. The principal reason for that is Japan's heavier dependence on exports. A rising yen poses serious problems for Japanese exports by making them more expensive to foreign buyers. A weaker yen gives a boost to Japanese exports and its stock market. Chart 1 shows a "negative correlation" between the Nikkei 225 and the Japanese yen since the start of the year. A big upturn in the yen during March coinicided with a sharp downturn in the Nikkei (see arrows). A sharp drop in the yen during October (green down arrow) coincided with the start of a rally in the Nikkei (orange up arrow). With the yen having fallen (against the U.S. Dollar) to the lowest level since the spring, the Nikkei has risen to the highest level in eight months. This isn't a short-term phenomenon. Chart 2 shows both markets trending in opposite directions over the last decade. The most notable turn took place in mid-2007 when a surging yen coicided with a plunge in Japanese stocks. The second turn took place in late 2011 when a peaking yen coincided with an upturn in the Nikkei. The moral of the story is that the best time to buy Japanese stocks is when the yen is falling.
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Chart 1
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Chart 2
EMERGING MARKETS OUTPACE THE US... I've been writing recently about greater strength in foreign markets, owing mainly to a weaker U.S. dollar and stronger foreign currencies. I've focused mainly on developed markets and a rising Euro. I'm going to show the same pattern in emerging markets today. Chart 3 compares Emerging Markets iShares (EEM) to the WisdomTree Emerging Currency Fund (CEW). [The CEW includes eleven emerging currencies). First of all, the chart shows both lines trending in the same direction (which is the opposite of what we see in Japan). The chart also shows a "double bottom" taking place in the currency index between last November and June (see circles) coinciding closely with upturn in the EEM. That means that money is flowing into emerging currencies and stocks. The solid matter below the chart is a ratio of the EEM divided by the S&P 500. That ratio bottomed over the summer and has broken its down trendline. Emerging market stocks have been doing better than the U.S. since the start of September. The biggest emerging market gains have come from Asia (India, China, South Korea, and Taiwan). The EEM is nearing a test of its spring high which will be a major test of its uptrend.
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Chart 3
WATCHING THE VIX... It's been a long time since I've written about the CBOE Volatility (VIX) Index. Since it doesn't seem to be attracting much attention, I figured this was a good time to revisit it. The VIX Index is a measure of 30-day implied volatility for options on the S&P 500. The VIX usually trends in the opposite direction of stocks. In other words, a rising VIX Index usually coincides with falling stock prices. Chart 4 shows that happening three times over the last four years -- during 2008, 2010, and 2011 (arrows). Each upturn in the VIX from below the 20 level coincided with stock market weakness. Market bottoms usually occur with the VIX peaks near the 45 level. Chart 5 compares the two indices over the last two years. A modest upturn in the VIX in spring 2012 resulted in a downside correction in stocks. The box to the lower right shows the VIX trending sideways below 20 since August. So far, however, it hasn't turned up. That suggests that although options protection is relatively cheap, traders haven't felt the need to buy much of it. In other words, they haven't been too worried about a market downturn. That could change if the VIX were to exceed its November closing high at 19.08. A decisive close above that resistance barrier would turn the VIX trend higher. If history is any guide, that would be a short-term negative for stocks.
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Chart 4
