Friday, May 11, 2007

The Spread Police (Comments now allowed)

If you've been lamenting the under-performance of your favorite Japanese equity market index (like MacroMan and other foreign punters), imagine the frustration of those who have NOT not hedged their currency exposure. As it stands, the Japanese equity returns in dollars (see above left chart of MSCI-Japan) has yielded little in nominal terms over the past 18 months. More interesting, is the inverse correlation over the past 18 months, which has been volatility-snuffingly high. And while the strength of the inverse correlation may be new, the lack of return to the Nikkei in USDs over the long term is not (as depicted right).

Returning back to my main point, the inverse correlation between the USD/YEN and the Japanese benchmark equity-index-of-choice is truly uncanny. It is as if some secret order maybe the The Spread Police have been contracted to watch over every tick in order to insure that none are errant, and so that said relationship is not jostled free by emboldened feedback-trading trendfollowers searching for sufficient change impulse.

Now, if they in fact, existed, who, or what, would these "spread police" actually resemble?? Would they have families? Would they acknowledge their profession? Who would pay them?

Might they look like this?:

or perhaps this?:

Or what about....:


My spouse suggested...

My 5yo son assures me that they are...

Those who think it is a more nefarious, 2nd-order effect might think this:

At first, I thought...

Though after much rumination, my best guess, was more umm ... errr .... mechanized....

But in all earnestness, what has caused the Topix vs. USD/JPY relationship to be caught in this financial "eddy" for the past 17 months? For it hasn't alway been so, as seen in the long-term chart of the Topix in USDs in the second graph from the top. Of course, there remains a measureably-large dollar sensitivity amongst the shares of the largest enterprises many of whom indeed depend upon US exports and world trade, historically overly-dependant upon the strength of the USD. But this reality has existed nearly since I cut my wisdom teeth, so why now??

And one would be forgiven for considering ZIRP & nearZIRP as the culprit, though it too is almost a decade old and has seen both currency moves and index moves that has swamped the relationship. So why so little vol? While William of Occam would no doubt attribute it to that which is most likely - the fact that not even gaijin equity investors, be they pension funds or central banks, want to hold YEN thanks to ZIRP - the lack of certainty is making me edgy. For low vol periods in high-vol instruments and the apparent relationships that causes them is making me feel decidedly unsettled.

(BTW - for those admiring the chinese-looking "soldiers", they are in fact North Korean border guards "walking the line" as Jack Nicholson said in "A ew Good Men", or in this case, sitting on the wall. I used it not to intentionally mislead, but just because I liked the pic! -C-.)


James said...

I think the only conclusion is the obvious one. The yen carry trade has gone out of control and the longer it works the more self reinforcing it becomes. Memories or fears of tough fed or boj are gone replaced with the attitude the market knows beter than policy makers.

"Cassandra" said...

I personally do not think that they have handed over the keys to the market from an ideological point of view. I think the market, like a delinquent teenager, has stolen the keys, and Central Banks, while aware of teh problem, are rather unsure how to re-approrpiate them without causing an awful wreck.

Not being a champion for corporal punishment, I do think the only really effective way to discpline the leveraged specs is to either engineer a good painful spanking once in a while to teach them respect, and make it known that in any cleanup they will be told to go to the back of the queue.

James said...

I guess thats the rub. A spanking without a complete breakdown thats turns this whole system into the next fannie mae.

Anonymous said...

Fannie Mae? Don't you mean Fanny Adams?