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Japanese Yen – a Negative Beta Indicator

Japanese Yen – a Negative Beta Indicator

Sunday, October 26, 2008
By Adam Perl

The markets experienced another action-packed week as continuous worries about the economic situation sent the major indices plummeting across the globe. Even though the intensity began to pick up during the week due to various economic data and comments from ex-Fed chairman – Alan Greenspan, most of the volatility was felt towards the end of the week as the Asian markets yet again pushed the “sell-off†button, causing global indices to perish. The U.S market gapped down on Friday following the opening bell by over 5%. In addition to all the anxiety in the market, earnings of various leading companies fell short of their estimates, dropping like bricks. Gold, once classed as a safe haven during economic problems, continued its path down last week touching a low of $681 per ounce before retracing back part of its losses. To date, after extensive monetary actions the low yielding Dollar has become the new “safe-havenâ€. Even though interest rates of other economies are still yielding much higher interest than the U.S’s 1.5% fund rate, expectations of further rate cuts among deteriorating economies like the U.K is sending money back into the U.S Dollar. The Greenback continued to rise last week against most of its counterparts, excluding the Japanese Yen. The Dollar index bounced higher throughout the week and is now trading at 86.42 points. When analyzing the charts one can see that the lowest yielding currency pair, the Japanese Yen, yielding only 0.5% is rallying against the U.S Dollar. Why would investors prefer a 0.5% return when they can receive higher interest on other currencies?

A Walk down history Lane

After World War II most of Japan’s economy was demolished, millions of citizens were jobless and the government’s main aim was to rebuild the economy back up from scratch. For years to come, Japan’s economy based itself on manufacturing, services, shipping, machine tools and exporting motor vehicles which seemed to be the economies main source of income. The irony is, that those same countries that demolished Japan’s economy, such as the U.S, helped reestablish it by becoming their prime consumers through exports.
Even though Japan’s economy faced many obstacles along the way: other growing economies that based their incomes on those same goods and rising oil prices that had peaked twice during the 70’s and 80’s, japans economy managed to stay afloat because of cheap labor and competitive costs.
In 1979 Japan entered a new field, production of semiconductor chips along with technology. Not knowing that the outcomes of this new era would lead to catastrophic results for years to come, the economy entered a period of rapid growth which affected it in two ways:
1)    Rapid growth led Japan to be the second leading economy market in the world after the U.S
2)    Mass uncontrolled growth led the markets into a bubble, waiting to be burst. Prices were extremely high and the stock market at that time had money flowing into it making stocks well over priced.
In 1989, after examining the economy along with other factors, the Bank of Japan (BOJ) decided to take control of the situation by using monetary tightening in order to calm the economy down. This move by the BOJ triggered a mass selloff and led it to a wide spread recession, which has been lingering on the economy until today.
The situation had become so bad that in order to encourage consumer consumption and growth the BOJ dropped its monetary interest rates to near zero, hoping to pull the economy out of this dire situation.
Low interest rates gave companies the opportunity to take loans with hardly any interest; but instead of encouraging growth, it had the opposite effect of putting fear into the population, who’d rather save their money in case of worse times to come, forcing the BOJ to maintain a low interest rate policy. 
 
Carry trades

While Japanese companies were struggling, foreign companies were galloping forward as their economies expanded at a rapid pace. As global economies and major indices raced forward forcing central banks to raise their interest rates (to control inflation), the difference in interest rates between Japan’s rate of 0.5% and other economies high rates presented investors with excellent investing opportunities. It is a well know fact that hedge funds and large firms yield on average 11% per year. If that is the case, carry trades (selling a low yielding currency and buying a high yielding currency) presented those investors with excellent returns. At the peak of economic growth, last year, the New-Zealand Dollar was yielding 7.5%. Selling the Japanese Yen currency, or taking a loan from Japan at 0.5% and investing it in the New-Zealand Dollar, yielded on average a 7% yearly return (only if the New-Zealand Dollar would gain value over the years – which it did). Investment firms choosing this type of investment had 63% of their 11% covered – “Easy Moneyâ€.
Where things went wrong
Over the last year central banks have been forced to reduce their interest rates to stimulate the economy, due to the ongoing dire situation. The extreme interest rate reductions ( the U.S reduced their interest rates from 4.25% to 1.5%) has forced investors to bank returns on interest rate differentials, closing their positions, sending money back to the Japanese Yen. As global economies and indices dropped, the Yen has regained its strength, gaining against most of its counterparts.
Taking a glance at the comparison chart below, one can see the negative correlation between the Japanese Yen and the S&P500.
 
 
  *courtesy of stockcharts.com

 Japanese Yen – A negative beta indicator.
Over the last couple of weeks, many analysts have been talking about a situation where the U.S indices might have found a bottom. Even though the S&P is currently trading in a bearish triangle, Friday’s session presented an inverted hammer on the SPY (see dojit’s school for further information) closing the session around support. Monday’s session will be thoroughly observed as a break of support will lead the indices and carry trades much lower. Support around current levels could revive sentiment leading the indices to a slight correction.
As this market has become a headline driven market, meaning that the news is influencing the market’s current direction, one can only turn to significant indicators when analyzing today’s markets. Once panic dies down, indices will begin to gain strength on expectation of economic growth. The Yen will lose its value as counterparts will regain their strength on interest rate increases. The Yen will yet again continuing its negative correlation or as I call it -the negative beta indicator.
 
* Beta- A statistical measurement that compares the volatility of a security compared to the overall market. A reading greater than 1 indicates that the security is more volatile than the market. A reading less than 1 indicates that the security is less volatile than the market. For example, EBAY’s beta is 1.34 meaning that if the market moves up, the stock will exceed slightly higher than the market itself, percentage wise.
 
Technical Analysis

*courtesy of stockcharts.com
 
USD/JPY- Monthly Chart

*courtesy of netdania.com
 
GBP/JPY-Monthly Chart

*courtesy of netdania.com
 
 
AUD/JPY-Monthly Chart

*courtesy of netdania.com
 
NZD/JPY-Monthly Chart

*courtesy of netdania.com
 
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Information reliability and liability: The contents are solely aimed for the use of “Experienced” investors in the financial markets who are fully aware of the inherent risk of trading. I, “Adam Perlâ€, do not accept any liability for any loss or damage whatsoever that may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in our trading recommendations. I make no warranties or representations in relation to the Information (including, without limitation, in relation to its accuracy or otherwise) and do not warrant or represent that the services will be error free or uninterrupted. Copyright: This article is subject to and protected by the international copyright laws. Use of the information brought in this article is subject to making fair use only in accordance with these laws. It is not permitted to copy, change, distribute, or make commercial use of the information except with permission of the holders of the copyright. Risk Disclosure: The risk of losses involved in the transaction or speculations in the financial markets can be considerable. Please think carefully whether such trading suits you, taking into consideration all the relevant circumstances as well as your personal resources. Speculate only with funds that you can afford to lose.

About the Author

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