In Search of Bottom

Recently I discovered two interesting correlations between exchange rates of leading currencies and S&P 500 index.

First relation is very well-known. If you compare Yen-US Dollar exchange rate with S&P 500 index (or Dow-Jones Industrial Average) in long term, you get near-perfect reflection images of each other. When S&P 500 falls, yen rises and vise versa.

US Dollar per Japanese Yen Vs. S&P 500 Index

The explanation is simple – Yen is relatively undervalued in terms of other major currencies partially because of monetary policies of Bank of Japan which keeps benchmark rates low in order to boost exports and fight deflation. Because of the low rates investors prefer to lend the money in cheap yen, convert to high yielding currency like US dollar and take risk by investing in US stock market for even more returns. But as US market slows down, investors start abandoning US market and buying Yen to cover their positions as well as in search of a safe and strong export dominated economy where central bank is to defend currency and fight deflation. 

The second relation is bit more complex. If you compare Euro- Yen (Yens per Euro) exchange rate and S&P 500, you will find that they perfectly follow each. 

Japanese Yen per Euro vs. S&P 500 Index

Again investors borrow money in yen and invest in another high yielding currencies, instruments and derivatives. But the carry trade of Euro in terms of yen apparently also overlap S&P 500 index. This trade collapse is parallel to the S&P 500 index collapse.

Both the graphs represent institutional investors readiness to take risk in the market. Higher spreads between JPYUSD and S&P 500 means investor is willing to take higher risks for higher returns. As the spreads narrow, the willingness of the risk also reduces. The second curve represent anti-growth environment where investors are running from new ventures, and capital investments to safer environment. Both graphs also confirm a widespread economic slowdown to the degree of recession.

But the real question is does this mean we are closer the bottom that to the top? 

© Rohit Deshpande