Euro/Yen Weakness Points to Stable Stock Markets

By: Donald_W_Dony

In the September 9, 2010 Market Minute titled: US bond yields and the S&P 500, technical evidence indicated that 10-year yields were starting to rise. This data is key because bond yields and the S&P 500 trade in parallel patterns. Another signal of potential equity stability is now coming from the currency market.

The Euro/Yen "Carry Trade" cross, which trends in the opposite direction to global stock markets, appears to be starting to rollover. This currency cross has been advancing for over nine months, and at the same time, the broad-based Dow Jones World Stock Index (DJWSI) has maintained a declining trend. The potential reversal of this "Carry Trade" cross would imply an increasing probability of favourable equity markets in Q4.

But what is the "Carry Trade"? It is borrowing at very low interest rates (near zero) in Yen and using the loan to buy higher yielding assets elsewhere, such as in Europe. During the past 12 years, the trade has become standard business practice for many institutional investors. Perhaps the most popular form of the strategy exploits the recent yield gap between European and Japanese fixed income securities. However, as the Yen advances against the Euro, the currency trade loses profitability which in turn removes a source of capital from institutional traders.

Bottom line: The Euro/Yen "Carry Trade" appears to be in the early stage of reversing its nine month upward trend. As the DJWSI has a tight opposite correlation to the currency cross, this expected action should be positive for the world stock markets and increases the probability of a strong performing 4th quarter.

Investment approach: Thought the outlook for equity markets appears to be turning more favourable over the mid-term, many world stock indexes are overbought due the quick advance since early September. Investors may wish to wait for an expected retracement during the next 2 to 3 weeks for better prices levels to develop.

More research on market conditions will be available in the upcoming October newsletter.

Your comments are always welcomed.

By Donald W. Dony, FCSI, MFTA
www.technicalspeculator.com

COPYRIGHT © 2010 Donald W. Dony
Donald W. Dony, FCSI, MFTA has been in the investment profession for over 20 years, first as a stock broker in the mid 1980's and then as the principal of D. W. Dony and Associates Inc., a financial consulting firm to present.  He is the editor and publisher of the Technical Speculator, a monthly international investment newsletter, which specializes in major world equity markets, currencies, bonds and interest rates as well as the precious metals markets.   

Donald is also an instructor for the Canadian Securities Institute (CSI). He is often called upon to design technical analysis training programs and to provide teaching to industry professionals on technical analysis at many of Canada's leading brokerage firms.  He is a respected specialist in the area of intermarket and cycle analysis and a frequent speaker at investment conferences.

Mr. Dony is a member of the Canadian Society of Technical Analysts (CSTA) and the International Federation of Technical Analysts (IFTA).

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