by Kevin Klombies, Senior Analyst

Friday, June 15, 2007

Chart Presentation: Japan

The Bank of Japan wraps up a 2-day meeting today and the market is overwhelmingly convinced that there will be no increase in Japanese interest rates. There is some chance that the vote will not be unanimous or that the post-meeting comments will be sufficiently rate ‘hawkish’ to convince the markets that a rate hike will come in August but for the moment traders seem comfortable borrowing in yen to invest in higher yielding currencies like the New Zealand dollar.

To us this smacks of Mexico in 1994- 95 when hot money was buying Mexican tesebonos with yields north of 20% because it was obvious that the peso couldn’t decline against the dollar but… perhaps that is a story for another day (the peso did collapse, by the way).

The chart compares the Kuwait stock market with the Japanese yen futures. The point is that whenever the yen weakens the Kuwaiti stock market rises and vice versa. At present the yen is very weak the Kuwait stock market is clearly flying.

Below is a comparison between the Japanese yen and short-term euroyen futures. The break to new lows by the yen against the dollar appears to match the recent ‘flat’ trend for Japanese short-term yields. In other words to the extent that the Bank of Japan stops yields from moving higher the yen will respond by moving lower.

Below we show commodity pries from Japan’s perspective.

Given that raw materials prices have, on average, more than doubled in terms of the yen over the past seven years it is hard to fathom how Japan’s inflation rate can remain at or below 0%. The argument is that the Bank of Japan through a weak yen and low interest rates is doing everything in its power to create inflation. One has to be careful what one wishes for.




Equity/Bond Markets

Bear Stearns (BSC) and Goldman Sachs (GS) reported softer earnings yesterday and we have noticed a bit of price weakness (for a change) in the share prices of the Canadian banks. As such we thought we would return to one of our BIG PICTURE charts.

When Japan’s asset markets collapsed in 1990 it marked the start of a trend towards lower long-term interest rates and higher bond prices that helped propel the earnings and share prices of many of the major financials. The charts of the Bank of Nova Scotia (BNS) and BSC are shown at right scaled logarithmically to reflect the constant and compounding rate of share price appreciation that began in 1990.

Our view is not that these stock prices are going to collapse but rather that as Japan’s interest rates finally rise the days of 18% annual compounding stock price gains (plus dividends) will end. Considering the length of time that consumer stocks like Coke, retailers like Wal Mart, and virtually everything to do with tech and telecom have consolidated it is possible that five or ten years from now the share prices of BSC and BNS will be virtually unchanged from current levels. Our sense, however, is that real negative pressure may not show up in earnest until Japanese 10-year yields rise above 2.0%. Last seen yields were close to 1.95%.

Below is a comparison of copper producer Phelps Dodge (PD), the Hong Kong stock market (Hang Seng Index), and the S&P 500 Index from 1997.

PD peaked in June 1997 but generally held near the highs into August at which time the Hang Seng peaked and turned lower. The SPX broke sharply back to the 200-day e.m.a. in October when the Hang Seng began to tumble.

The point is that as long as the mining stocks were making new highs the equity markets continued to push. We can see FCX (below) punching upwards on a daily basis so our thought is that we have to remain positive on equities until some time after these stocks roll over.