Currency Winds Now Favorable for Japan Stocks     

• The melt-up in US equities comes with a noticeably stronger USD and rising treasury yields. The inverse relationship between a stronger USD (risk avoidance proxy heretofore but now a recovery/normal monetary policy indicator now) and stocks is transforming into a more constructive positive correlation. At the same time, investors need to watch US bond yields, as too steep a rise combined with Fed extraordinary monetary policy exit strategies could blow the lid off mortgage rates and hobble stock prices.
• Conversely, commodity prices are now beginning to lag and with them, emerging markets. China stocks have veered off course with all of the pronouncements of an imminent popping of an excess credit bubble and US trade friction. Whether true or not, investors are now backing away from China stocks, and concern for China is hobbling commodities along with the stronger USD. Waning commodity prices are in turn hobbling emerging market stocks, which some believe have come too far, too fast and are fully valued for the time being. However, investors fleeing Euroland and China are re-allocating funds to other Asian markets.
• As we expected, the JPY/USD rate is breaking through JPY90/USD toward JPY100/USD. While JPY is still appreciating versus EUR, the trade-weighted JPY index has also broken through 40-week MA support. Thus the currency winds are now favorable for Japanese stocks. If the US does succeed in pushing China to allow the Yuan to appreciate further, this will also help restore competitive advantage to Japanese exports and provide further support for stocks. Supply-demand wise, foreign investors remain the primary drivers of Japanese stock prices, which is something investors need to continue to monitor.
• As we said last week, however, the case for Japan is not a top-down buy according to a market-cap weighted index scenario. One look at the poor performance of Japan�fs banking sector should be evidence enough that the investment story for Japan is not a passive top-down story. Rather, it is a bottom-up stock selection story, concentrating on smaller capital companies with strong and growing businesses in Asia/emerging markets, where valuation-changing growth lies.

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