Another day, another record high for the US benchmark indices. The S&P 500 rose 0.18%, and the Dow was up 0.12%. This relentless surge higher continues despite the ending of QE by the Federal Reserve AND the prospect of higher interest rates in the US.
The Bank of Japan (BOJ), that’s who. And aren’t they giving it some? Don’t you think it’s an uncanny coincidence that a mere few days after the fed turned off their liquidity tap the BOJ turned theirs up full bore?
Yes, of course it’s just a coincidence. Central banks do act independently of each other. The big increase in Japan’s QE program has absolutely no impact on global asset prices…especially US asset prices. Look, that’s plain to see from the chart below…
Hang on a minute. It’s not plain to see at all. What’s it telling you then?
The red line shows the USD/YEN exchange rate. Its sharp rise since late October reflects the additional QE announcement by the BOJ. That weakens the yen against the US dollar, and encourages traders to sell yen and buy US dollars and US dollar denominated assets, like the S&P 500, which is the black line in the chart.
In other words, a weak yen equals higher US stock prices.
So if it’s yen weakness as the primary short term driver of US stock markets, then you should probably expect a pull back over the next few weeks. That’s because the yen is now massively ‘oversold’ against the US dollar.
Let me show you what I mean. The chart below shows the very recent performance of the yen against the US dollar. If you look at the top of the chart, you’ll see that the ‘relative strength index’ (RSI) is in oversold territory (shaded bit) and has been since the BOJ’s announcement at the end of October.
This condition can persist for some time…and it did throughout late August and all through September. But eventually balance comes back into the market as traders take profits. That will happen again soon and when it does — if the current relationship continues to hold — US markets should take a breather.
More QE from the BOJ may be good for markets and speculators, but is it any good for Japan? William White, ex Bank for International Settlements economist and predictor of the financial crisis, reckons not. Writing an op-ed piece in the Financial Times, White says more QE is unnecessary and will do nothing for economic growth:
‘First, the reason it is not needed. Japan’s recent slow growth has been largely driven by demographic trends. Since 2000 growth in GDP per person of working age has been significantly above that in the US. As for anxieties over persistent deflation, the level of Japanese consumer prices has fallen less than 4 per cent in the past 15 years. There is no evidence of an accelerating deflationary trend, nor of consumers delaying spending in anticipation of lower prices. Indeed, the household saving rate has fallen since the 1990s from a traditionally high level to zero.
‘Second, why it will not work. The underlying intention is to induce businesses to invest and export. Neither seems likely to happen. Japan’s smaller companies export little and face higher costs of imported goods and services as a result of a weaker yen. Its bigger ones have long had the advantage of favourable financing conditions and large cash balances. They have not responded with more domestic investment. Why should they do so now in the absence of the significant structural reforms promised by Shinzo Abe, the prime minister?’
He then talks about the difficulty of managing the process of QE should interest rates on government debt start to rise. Once that happens, things will get out of control. As White says, ‘Confidence everywhere would be seriously affected should it become clear Japan’s authorities were losing control of events.’
Would such an occurrence start the signal of a major stock market melt-up around the world? You just saw how the S&P 500 responded to a weaker yen. If it continues to weaken materially, would this relationship keep pushing US stocks higher?
What about in Australia? The correlation with the Aussie market is much tighter. Below is a longer term chart that shows the Aussie/yen exchange rate (red line) plotted against the performance of the All Ordinaries index.
As you can see, it’s a pretty tight and long term correlation. It shows that yen weakness is bullish for Aussie stocks while yen strength is bearish. That makes sense. For years, markets viewed the yen as a defensive or safe haven play. That is, buy yen as equity markets fell.
But now that the BOJ has turned the QE dial up to 11, could that be changing?
You’ll have to wait and see. There are some early signs that change is afoot. It you look at the right hand side of the chart above, you’ll see that Aussie strength versus the yen (rising red line) has not translated into similar strength in the Australian stock market.
It did for a few weeks, but the iron ore shakeout of the last week or so smashed the market lower. The two iron ore majors, BHP and RIO, look particularly weak and at risk of heading much lower in the coming months.
That leaves the banks — again — as the main support for the Aussie market…and the economy for that matter. Perhaps if enough BOJ produced liquidity escapes the yen and ‘hides’ in the Aussie banking system, it can lift our market to new highs.
Who knows? One thing’s for certain, in an unsound monetary world, expect anything. The prospects of a crash or a crack-up boom are about equal. Blame it on the BOJ. They’ve already lost the plot, now it’s just a matter of time before they lose control.
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