GERMANY LEADS EUROPE HIGHER -- A STRONGER EURO IS ALSO HELPING -- VANGUARD EUROPEAN ETF IS A GOOD WAY TO BUY EUROPE -- FALLING YEN HAS MADE JAPAN WORLD'S STRONGEST MARKET OVER LAST YEAR
GERMAN DAX HITS NEW RECORD -- GERMANY ISHARES ALSO BREAKOUT... Europe has been emerging as one of the world's stock market leaders. A lot of that has to do with strength in Germany which is the region's biggest economy. The last week's impressive victory by Angela Merkel and her center-right Christian Democratic Union (CDU) had a positive impact on German stocks and the rest of Europe. The monthly bars in Chart 1 show the German DAX Index trading at a new all-time record (see circle) after having exceeded its 2000 and 2007 highs. It's the first country in Europe to do that (although Britain may be next). The weekly bars in Chart 2 show Germany iShares (EWG) breaking through its 2011 peak to reach the highest level in five years (circle). In case you're wondering why the ETF is trailing behind the DAX, look at the two lines below Chart 2. The blue line is a "ratio" of the EWG divided by the DAX. The declining ratio since 2008 shows the EWG lagging behind the DAX. It has been doing better, however, over the last year (a rising ratio). The reason for that is the stronger Euro (green line). The trend of the Euro since 2008 closely parallels the trend of the EWG/DAX ratio. Both lines are testing five-year down trendlines. An upside breakout in the Euro would give a bigger boost to the German ETF. The reason for that is because the EWG is quoted in dollars. A weaker dollar (stronger Euro) would make the EWG gain more ground than the DAX. That's true of all foreign ETFs, and supports the intermarket principle that foreign stocks (especially ETFs) do better than U.S. stocks when the dollar weakens.
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Chart 1
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Chart 2
VANGUARD EUROPEAN VIPERS ARE STARTING TO OUTPERFORM US STOCKS... Chart 3 shows the Vanguard European VIPERS (VGK) reaching a five-year high (see circle). [The regional ETF includes stocks from eighteen European countries, which include Britain] The dashed line plots the VGK/SPX ratio. After falling since 2008, the Europe/U.S. ratio has formed a positive pattern of "rising bottoms" over the last year (rising trendline) and is starting to do better than the SPX. [A firmer Euro and weaker dollar are big reasons why]. Another reason may simply have to do with the fact that U.S. stocks have done so much better than Europe over the past few years and are now somewhat overextended. That suggests that some global money has started to rotate out of an overbought U.S. market (which is facing another budget battle in Washington and the threat of a government shutdown). Some of that money is finding its way into a stronger Europe.
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Chart 3
JAPAN IS ALSO TURNING INTO A WORLD LEADER ... Japan has been one of the world's weakest stock markets over the last decade. That may be changing. The monthly bars in Chart 4 show the Nikkei Average surging to a five-year high over the last year. In so doing, it became the world's strongest performer. Since last October, the Nikkie has gained 67% (versus 18% for Germany and 17% for the U.S). The solid matter below Chart 4 plots a "ratio" of the Nikkei divided by the Dow Jones World Index (DJW). The rising ratio during 2013 shows that Japan has become a new world leader. Since last October, the Dow Jones World Stock Index has gained 16%, about a quarter of the gain in Japan. The resurgence in Japan (if it continues) may have a major impact on other markets around the world. It may also alter the long-term relationship between global bonds and stocks.
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Chart 4
STRONG YEN HAS HURT JAPAN... Japan has been plagued by deflation since 1998. Part of the reason for that deflation has been the strength of the Japanese yen. Between 1998 and 2012, the yen was the strongest currency in the world. A rising currency is deflationary. Deflation is bad for a country's stock market (but good for bonds). The green bars in Chart 5 show the Japanese yen rising from 1998 to 2012. The orange area shows the the Nikkei/ DJ World Stock index ratio falling during those fourteen years. Since the fourth quarter of 2012, however, a collapsing yen has boosted Japanese stock performance (see circles). In fact, Japan has turned in the strongest "relative" performance since 1998 when the yen started to rise. While Japanese stocks were the world's strongest over the last twelve months, the yen has been the world's weakest currency. Japanese leaders have made it clear that a weaker yen is intended to end more than a decade of Japanese deflation. If the Japanese plan works, that could carry important global implications.
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Chart 5
JAPANESE DEFLATION MAY EXPLAIN LOW BOND YIELDS... In my last two books on intermarket analysis (2003 and 2013), I argued that deflationary tendencies that impacted global markets over the last decade came mainly from Japan (which is the world's third largest economy). I further argued that a correlation existed between weak Japanese stocks and falling U.S. Treasury bond yields. Chart 6 demonstrates that by comparing the 10-Year T-Note Yield (green line) to the Nikkei/World Stock Index ratio since 1998. Both lines fell between 2000 and 2003, rebounded into 2006, and then fell together until 2012. It's interesting to see that Japan's stronger relative performance over the last year has also coincided with a jump in U.S. bond yields (see circle). "Correlation" doesn't always equal "causation", but I suspect there is some causality at work here. If Japan's relative weakness (caused by deflation) contributed to the strong performance of global bonds over the last decade (and weaker global stocks), it could be argued that Japan's emergence from deflation should have the opposite effect. Bonds thrive in a deflationary environment. Stocks do better when deflationary forces start to lift. That process may have already started in Japan.
