Two Inversely Correlated Asset Classes Provide Lifeline and Noose for S&P 500

U.S. equities are part of an intricate global financial ‘ecosystem.’ They do not trade in a vacuum. As part of something bigger, U.S. equities are subject to certain correlations, which provide clues about U.S. stocks’ next move.

U.S. stocks do not trade in a vacuum; they are part of an intricate ‘ecosystem’ of worldwide financial markets.

As with any ecosystem, financial markets adhere to the ‘cause and effect’ principle.

Just like there’s a correlation between birds of prey and the mice population or bees and pollination, there are correlations between specific financial markets (some are directly correlated, others are inversely correlated).

Understanding market correlations/connections can be helpful in forecasting stock market movements.

Some of those financial ecosystem correlations are:

  1. U.S. stocks (or S&P 500) and the Japanese yen
  2. U.S. stocks (or S&P 500) and U.S. Treasuries

S&P 500 vs Japanese Yen

Due to the carry trade, the yen has become an important force for the S&P 500.

As part of the yen carry trade, U.S. investors borrow yen to buy U.S. stocks. The yen can be borrowed cheaply and U.S. stocks have delivered juicy returns in recent years.

Courtesy of Japan’s Prime Minister Shinzo Abe, a falling yen makes paying back the yen even cheaper and has made the carry trade even more attractive.

A rising yen would have the opposite effect on U.S. stocks.

The Japanese Yen Futures chart below shows the yen butting against double trend line resistance and the 200-day SMA.

S&P 500 vs 30-Year Treasuries

Bond investors have a reputation to be smarter than stock investors. I like to monitor 30-year Treasury bond prices (corresponding Treasury ETF: TLT) as they tend to have an inverse correlation to the S&P 500.

On April 2, 30-year Treasury prices found support at the green trend line. The April 2 Profit Radar Report stated that: “30-year Treasuries have reached near-term support. Prices tend to respond to such trend lines, so a bounce is possible. A bounce for Treasuries would provide headwinds for higher stock prices.”

30-year Treasury Futures bounced from support and now trade above double trend line resistance. This bullish breakout (assuming it sticks), suggests lower prices for U.S. stocks.

Although those charts don’t tell us the up side potential for the yen and Treasuries (or down side risk for the S&P 500), they do tell us that we are at a pivotal point in time.

The S&P 500 (NYSEArca: SPY) chart confirms the message of yen and Treasuries and provides clear ‘points of ruin’ or must hold support levels.

Here is the most important near-term support level:

Don’t Get Fooled by This S&P 500 Bounce

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Will The ‘Risk on’ Trade Live on?

The market has been alternating between ‘risk on’ and ‘risk off,’ with a heavy emphasis on risk on. A look at stocks shows that risk on is still alive and well, but here’s one fact that hasn’t confirmed the most recent spout of risk on.

‘Risk on’ in one of those fashion terms linked with the QE bull market and expresses investors’ comfort level with high-risk assets.

Will risk on continue to live on?

Risk on received another shot in the arm by Shinzo Abe (Japan’s Prime Minister) and his easy money policy.

How exactly does Abenomics affect the domestic stock market?

Big Boy’s Printing Machine

The yen carry trade is like an ATM for the big boys of investing. A normal carry trade would see big institutions borrow money in countries with low interest rates and invest the money in fixed income vehicles of countries with high interest rates.

For example, if the yen had zero interest rates and U.S. bonds yielded 5%, a firm would want to borrow yen and buy U.S. bonds for a nice spread (positive carry). The biggest risk is a rising yen.

The modern yen carry trade is slightly different. Both the U.S. and Japan are pursuing a 0% interest rate policy. Institutions now borrow the yen and buy U.S. stocks.

The chart below plots the S&P 500 against the Japanese yen. The yen could also be represented by the CurrencyShares Japanese Yen Trust ETF (NYSEArca: FXY).

The widening margin between the S&P 500 and yen is the ideal carry trade scenario. The wider the gap, the bigger the yen carry profits (a falling yen makes the yen loan cheaper).

The second chart plots the S&P 500 (NYSEArca: SPY) against the USD/JPY currency pair.

The USD/JPY currency pair measures the value of the dollar and yen in relation to each other and reflects how many yen are needed to purchase one U.S. dollar.

Up until early February the correlation has been tit for tat. But the USD/JPY pair did not confirm the S&P’s recent rally. Why?

A closer look at USD/JPY provides interesting insight:

The USD/JPY pair is struggling to overcome resistance around 103.70, which is made up of the May 2013 high, ascending red trend line resistance and 61.8% Fibonacci retracement (going back to January 2 high).

While this confluence of resistance is the perfect spot for the USD/JPY rally to stop, it’s too early to say if it is enough to stall the risk on track.

103.70 is the dividing line for the risk on yen carry trade.

As long as USD/JPY stays below 103.70, carry trade and U.S. investors may have to deal with a risk off environment for a bit.

Those who have a hard time believing that there’s a rhyme and reason for the ebb and flow in the investing universe may enjoy the following article.

Although the S&P 500 has surpassed its previous all-time high (unlike USD/JPY), the S&P 500 is at a similar inflection point.  What does it mean? Details here:

Is it Too Late to Jump into Stocks? Watch S&P Reaction to This Inflection Point

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

VIDEO: How Much Lower Can the Yen Fall?

The Japanese government is planning to unleash another fiscal stimulus to boost the nations shrinking economy. I’ve lost track of the number of financial stimuli, but they are no doubt in the double digits. The next one is expected to be $136 billion.

No wonder investor confidence in the Yen is at an all time low. Small speculators are now holding a record amount of short positions. Thus far this hasn’t prevented Japan’s currency from a continuous slide lower.

Catching a Yen bottom now is like catching the proverbial falling knife and waiting for the first failed bearish low-risk entry before going long is prudent. This video highlights the first bullish signs of life that often provide fertile soil for extended rallies. Investors can get exposure to the Yen via the CurrencyShares Japanese Yen Trust (FXY) currency ETF.

>> Click here to watch video