BIG MOVE BY JAPAN PUSHES GLOBAL STOCKS SHARPLY HIGHER -- THE PLUNGING YEN PUSHES JAPANESE STOCKS TO SEVEN-YEAR HIGH -- DOW RECORD HIGH CONFIRMS TRANSPORTATION BREAKOUT -- S&P 500 HITS RECORD CLOSE AS SMALL CAPS JUMP

JAPAN ANNOUNCES BIG JUMP IN ASSET BUYING... Japanese authorities surprised everyone on Friday by increasing their already aggressive bond purchases (QE) by a third. In addition, it will expand those purchases to include stocks and real estate investments. The Japanese pension fund also announced that it will increase its allocation to domestic and foreign stocks. That gave a huge boost to global stocks. The most dramatic effect was seen in Japan. Chart 1 shows the Japanese yen tumbling to the lowest level in seven years. At the same time, the Nikkei Index surged nearly 5% to the highest level in seven years. We've pointed out many times before that the falling yen since the end of 2012 has been the main driving force behind Japanese stock gains. That was certainly the case again this week. The monthly bars in Chart 2 show the Nikkei also climbing above a major resistance line drawn over its 1996, 2000, 2007 highs. That upside breakout suggests that Japanese stocks may finally be emerging from their role as one of the world's weakest stock markets. Since the start of 2013, the Nikkei has risen 57% versus a 28% gain in the Vanguard All World Stock Index (and a 41% gain in the S&P 500). Japan is trying to emerge from nearly two decades of deflation. The latest Japanese inflation figure of 1% is only half of the target rate of 2%. It still has a ways to go.

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Chart 1

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Chart 2

BE SURE TO HEDGE OUT WEAKER YEN ... I've written before about the need to hedge against a falling yen when buying Japanese stocks. That can make a huge difference. The green line in Chart 3 shows the Wisdom Tree Hedged Equity ETF (DXJ) surging to a new seven-year high on Friday. By contrast, the orange bars show Japanese iShares (EWJ) trading well below its 2014 highs. That's because the EWJ is quoted in U.S. dollars, and doesn't hedge out the falling yen. The DXJ does. Since the start of 2013, the DXJ has gained 53% versus a 27% profit in the EWJ. [The Nikkei itself gained 57%]. A -23% loss in the yen accounts for most of the difference between the two ETFs. Foreign investors who buy Japanese stocks also indirectly own the yen. Yen losses detract from Japanese stock gains. That's why the DXJ is the most popular way to invest in Japanese stocks.

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Chart 3

ANOTHER DOW THEORY BUY SIGNAL ... Chart 4 shows the Dow Industrials closing above its September peak at a new record high. That confirmed the previous upside breakout by the Dow Transports that took place earlier in the week (top of chart). According to Dow Theory, the upside breakout in both averages confirms that the bull market in stocks in alive and well. The Dow Utilities (below chart) also hit a new record. That puts all three Dow Averages in record territory.

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Chart 4

S&P 500 HITS RECORD CLOSE -- SMALL CAPS TURN UP ... Chart 5 shows the S&P 500 hitting a new record closing high on Friday. And it did so on rising volume. Small caps turned up as well. Chart 6 shows the Russell 2000 Small Cap Index ($RUT) gapping through a resistance line extending back to early July. Friday's small cap gain of 1.5% was even stronger than the 1.1% gain for the SPX. During October, small caps rose three times as fast as large caps (6% versus 2%). That's the first time we've seen small cap outperformance since the spring. And it's a very encouraging sign. Sector leadership for the week came from technology (semiconductors), financials (banks), healthcare (biotechs), and industrials. Three of those are economically-sensitive. Coemmodity stocks were again the weakest. That's because the surging dollar pushed commodity prices even lower -- especially gold.

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Chart 5

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Chart 6

GOLD AND MINING STOCKS TUMBLE ... Gold mining stocks lost -15% on the week to make them the worst performers in the stock market. The weekly bars in Chart 7 show the Market Vectors Gold Miners ETF (GDX) falling to the lowest level since 2008. That was because of the drop in the price of gold to the lowest level in four years. Gold has at least two things working against it. One is the stronger stock market. Stronger stocks diminish the appeal of gold as an alternative asset. The other is the surging dollar. The green bars in Chart 8 show the U.S. Dollar Index ending the week at the highest level in four years. Meanwhile, the orange bars show the price of gold falling to the lowest level in four years. Bullion is also breaking down from a bearish "descending triangle" that's been forming for over a year. [A descending triangle shows two converging trendlines where the upper line is falling an the lower line is flat. A drop below the lower line resumes the downtrend].

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Chart 7

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Chart 8

RISING DOLLAR MAY KEEP INFLATION DOWN... My Wednesday message suggested that the Fed probably wouldn't do anything to push commodity prices lower, which would lower inflation expectations here and globally. The Fed's preferred inflation measure fell to 1.4% this month, well below its 2% target. Eurozone inflation at 0.4% is also dangerously low. The Japanese move this week was partially in response to a falling inflation rate near 1%. The Japanese mentioned the drop in oil as one of the contributing factors to falling inflation. Which raises an obvious question. The Fed's more hawkish comments this week (combined with Japanese actions) served to push the dollar higher against all major currencies. In addition, the Fed stated this week that low inflation was expected to be "transitory". That may not be the case if the dollar keeps rising. A rising dollar, and weaker commodities, may prevent inflation from rising to desired central bank targets. The good news is low inflation may keep U.S. rates lower for a longer period. Just when it seemed like the Fed was taking away our punch bowl, the Japanese gave us another one to keep the party going. Europe may be next.