Friday, January 29, 2010

Short Yen, Long Dollar

The US Dollar should outperform the Japanese Yen, which is on the cusp of a secular down trend.

Figure 1 is a monthly chart of the USDJPY cross rate with the "next big thing" indicator in the lower panel. The "next big thing" indicator was developed to help identify those assets that are most likely to undergo a secular trend change from bear to bull. The indicator looks at those technical characteristics that are mostly frequently found at market bottoms prior to the change in trend. The indicator is unique in that it just doesn't rely upon the "oversoldness" of an issue (i.e., the y axis) but it also tries to assess how long (i.e., the x axis) the current down trend has gone on. For more on this indicator, check out this link, please.

Figure 1 USDJPY/ monthly

The indicator is now in the zone where a secular trend change is likely. Prior bottoms are noted by the maroon colored vertical bars, and we note that the indicator had difficulty identifying a bottom in the early 1990's. Thus, the indicator can alert us to the potential for a secular trend change, but I would always use price (i.e., a moving average crossover) to confirm that a change in trend has taken place.

Figure 2 is a weekly chart of the USDJPY cross rate. The yellow dots are key pivot points or areas of significant buying and selling. Key pivot points are special pivot points as they are a pivot low point occurring at a time when investor sentiment is bearish on the Japanese Yen(i.e, bull signal). In this case, the sentiment data for the Japanese Yen comes from MarketVane and it is their bullish consensus, and this data is hidden on the graph in figure 2.

Figure 2. USDJPY/ weekly

The pattern is this and it is pretty much the same pattern that I write about most of the time across many different assets: a close over 3 key pivot points should result in higher prices for the USDJPY cross rate. A weekly close below 89.364 on the USDJPY would suggest that this cross rate is going lower.

Of note, this is the same pattern that led me to write "Expecting The Dollar Index To Rise For 2010".

Fundamentally, the Yen should be vulnerable as chronic deficit spending and changing demographics of its population should result in higher interest rates and/or a weaker Yen. These dynamics are best explained by Kyle Bass of Hayman Partners, LP in this quarterly letter to his investors. See page 15 for his analysis of the secular dynamics afflicting Japan.

In summary, technical studies and fundamentals support a secular trend change in the Japanese Yen. From an ETF perspective, two ways to play this burgeoning trend is the ProShares Ultra Short Yen (symbol: YCS), which is a long 2x leverage product. The other way is to short the Currency Shares Japanese Yen (symbol: FXY).


Anonymous said...

Not just long USD, but short yen. Hmmm. Interesting. How does a weaker yen affect your bullishness towards Japanese equities? A weak yen used to be a plus, but will it be this time, do you think?

D-man said...


thanks for the analysis; I opened a small short position in yen a couple of weeks ago, I added a bit more to it recently.

I have a question for you

"Fundamentally, the Yen should be vulnerable as chronic deficit spending and changing demographics of..."

agree on that

"...its population should result in higher interest rates and/or a weaker Yen."

but why higher interests is a bad thing for the currency? I though the opposite is true?! I know this blog is more on TA than details like that...


Guy M. Lerner said...

According to Bass's letter to his investors, higher interest rates would be the result of Japan having to compete for capital from foreigners to finance its debt and obligations; current funding is met by Japanese savings but the demographics suggest a change; he believes they won't have a choice but to devalue the currency because the higher interest rate scenario will not be palatable