Who Wants to Bet Again on a Cyclical Turn in JPY?

• In November 2009, foreign investors had essentially given up on Japan as a hopeless basket case and JPY was peaking. Around that time, we began suggesting that Japanese stocks had a fighting chance for a decent rally in early 2010, predicated on a weakening trend in JPY to and below JPY100/USD. This “decent rally” lasted until April, when investors got a case of “double dip” and began again to take risk off the table, thereby sending JPY back toward historical highs. Basically, the strong JPY is only adding salt to the wounds of Japanese equities. If growing concerns of a double dip in the US and slowing growth in Euroland and more importantly China weren’t enough, JPY surging back to JPY85/USD was well beyond what exporters had been assuming in their FY2010 budgets, meaning forex losses on top of the feared weakening export volumes. The strong JPY has been an albatross around the Japanese market’s neck since JPY was trading weaker than JPY120/USD in June 2007, and nearly JPY170/EUR in July 2007. Since then, JPY has surged 42% versus USD and nearly 50% versus EUR. That is a massive swing that even aggressive fiscal stimulus, let alone the anemic countermeasures implemented so far in Japan, could offset.
• With JPY now again pushing the JPY85/USD, we are approaching the next fork in the road, i.e, when JPY will again peak out. Since the Nikkei 225 has a high negative correlation of 0.61 vis-à-vis JPY, cyclical peaks in JPY are an ideal time to establish medium-term (i.e., 6 months or so) trading positions in the export sectors, i.e., precisions, electronics and automobiles, as stock prices in these sectors discount currency movements real time. While the turn is contingent on a more relaxed attitude toward global growth and rising, not falling US bond yields, Japanese stocks will again have their brief 15 minutes of fame and outperform their global peers during the next JPY weakening phase. Meanwhile, the market forward P/E multiple is back to 2008 lows, or around 16X.
• Conversely, the Nikkei 225 has an even higher positive correlation with JGB yields (0.74), meaning that any new down-leg in JGB yields (ostensibly on more serious concerns about the economic recovery) should be taken as a warning that stocks are also headed for another down-leg, sending investors into an even deeper “risk off” mode.
  

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