The Yen Foretells a Long-Term Market Downtrend
Now I'm not so sure that the Japanese yen will retreat.
Japan's economy and, therefore, its stock market, have a a near perfect inverse correlation with its currency (see Chart 1 below). The higher the yen rises, the poorer the economy performs. It's simply due to yen's strong causal effect on Japan's export-centric economic policy. This is one of the parallels between the Japanese economy and our economy-to-be that I've referenced in the past. But, we'll leave that discussion for some other time.
After the Tokyo Nikkei Index took it on the chin for another 2.75% loss last week, which was preceded by a near 6% precipitous selloff in the week before, it had perhaps begun to dispel any hope of a major stock market comeback. And, the possibility of a Japanese yen's 3-peat performance of retreating from he multi-year resistance of 91.70 might've all but dissipated (see X marks on the weekly chart, Chart 2, below). The yen had actually closed the week above the prior week's closing price (little dots on the right side of the bar in the rectangular box). In addition, the yen's 52-week EMA had not only crossed above the 52-week SMA, but it had also started to widen the gap (thick black circle).
One of the easiest way to spot a potential trend reversal is using the crossover of the EMA (Exponential Moving Average) and the SMA (Simple Moving Average). The EMA assigns more weight to the most recent data. When this weighted average outpaces the simple average, it usually signals a shift in the momentum. The separation of the Japanese yen's 52-week EMA from its SMA counterpart indicates an important shift of the momentum to the upside. Since these are long-term moving averages, their crossover may imply the inception of a long-term uptrend. And, the yen's breakout of the 91.70-92.00 resistance would confirm the continuation of the trend.
It's also time for the yen to rise anyway, not on the merits of Japan's economy, but, rather, on the relative weaknesses of other major currencies, particularly the Dollar. Chart 3 below shows the Dollar-to-Yen and the Euro-to-Yen exchange rates. Both have exhibited signs of weaknesses after their respective peaks of 123.87 and 168377 in June and July.
One group suffered dearly from the 11% plunge of the USD/JPY exchange rate since June was Mrs. Watanabes, aka Japanese housewife-traders, who held the purse strings of Japan's $12.5 trillion in household savings. Japan's low interest rates compelled these household finance ministers to seek better, though riskier, returns from other high yielding currencies. Until the U.S. credit crisis in August, the value of foreign currencies traded online by Japanese private individuals averaged $10 billion A DAY. Their powerful influences led some professional money managers and strategists to believe that Japan's margin traders have the power to support other currencies against the yen. Of course, that was before the U.S. credit crunch. Many Japanese traders, who had doubled or even tripled their holdings as the yen moved primarily down against the Dollar, have now lost nearly all of their savings. We know now that even they can not support the Dollar against the yen.
If the yen had, in fact, begun a long-term uptrend, then the unwinding of the yen carry trade could mean the beginning of a long-term downtrend for the U.S. market. And, the correction that we've seen thus far, after the effect of the Fed's re-inflation effort had worn off, may have been just the beginning of a long-term downtrend (see Chart 4 below). Removing the "Fed Effect" from the DJIA chart below and moving the November market action to September seem to indicate the continuation of the correction that had started in July.