Leading Indicator: What the Yen Carry Trade Predicts for the S&P 500

Investors are always looking for leading indicators. Here’s one: The yen carry trade. This trade has been a recipe for success … until this week. Here’s what went wrong and what it says about stocks’ future.

Here’s a look at Wall Street’s moneymaking recipe box. Always delicious (except for this week), the yen carry trade feast.

The traditional yen carry trade is an interest rate play, where investors borrow yen and buy higher interest vehicles (which used to be U.S. Treasuries).

But, interest rates around the globe are close to zero, so there’s no margin.

The traditional yen carry has lost its spice. Here’s the new and improved recipe:

  1. Borrow yen
  2. Buy U.S. stocks
  3. Enjoy tasty profits (falling yen, rising stocks)
  4. Rinse and repeat …

The chart below shows the close correlation between the S&P 500 and the USD/JPY, which measures the value of the U.S. dollar in yen.

A falling yen and rising U.S. stocks turn both components of the carry trade (basically short the yen and long U.S. stocks) profitable.

But there are always two sides to a trade, and a rising yen (= falling USD/JPY pair) translates into double whammy losses.

That’s exactly what happened this week.

In other words, just as using sugar instead of salt screws botches a recipe, a rising yen (instead of a falling yen) turns Wall Street’s tasty profit formula into a bitter pill to swallow.

Due to the close S&P 500 / USD/JPY correlation, USD/JPY can be used as a leading indicator for the S&P 500 (NYSEArca: SPY).

What’s USD/JPY telling us about the S&P?

The Profit Radar Report featured the chart below in the March 12 update and made the following comment:

A rising yen (falling USD/JPY) would stifle this particular carry trade. The chart below shows that USD/JPY hasn’t been able to move above resistance at 103.70. The USD/JPY staying below 103.70 is one of the few clues that suggests stocks may actually move lower.”

Resistance at 103.70 is important, because it’s made up of three separate resistance levels meeting at the same spot:

  1. The ascending red trend line
  2. The May 2013 high
  3. 61.8% Fibonacci retracement of the points lost from January 2 to February 3

As it turns out, this resistance cluster was too much, the USD/JPY pair succumbed to the pressure, dragging the S&P 500 down as well.

By Friday the USD/JPY pair closed even below a minor support shelf, suggesting more down side to come.

Where is next support and could the unraveling of the carry trade turn into a bigger correction for U.S. stocks?

A detailed forecast for the S&P 500 is available via the Profit Radar Report.

The USD/JPY pair wasn’t the only factor that warned of impending down side.

Perhaps the most popular technical indicator known to Wall Street suggested the same thing, but surprisingly nobody picked up on it. More details here:

The Biggest S&P 500 Dilemma Explained in One Chart

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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MACD Did Not Yet Confirm Stocks’ Up Trend

There’s another indicator that hasn’t (yet?) confirmed stocks’ up trend. Compared to prior snap back rallies, MACD is moving quite slow this time around. It will take another push higher to convince MACD of this rally’s staying power.

There are leading indicators and there are lagging indicators.

Leading indicators (are supposed to) predict turns before they occur. Lagging indicators confirm a turn after it occurred.

It was a combination of leading indicators that prompted this forecast in the February 3, 5 Profit Radar Report: “There was a bullish RSI divergence. Selling pressure is subsiding. The potential for a roaring rally exists.”

The S&P 500 (SNP: ^GSPC) has overshot 1,830; the ideal up side target outlined by the February 9 Profit Radar Report.

Despite the strong rally, one lagging indicator has not yet confirmed the S&P’s up trend. MACD.

The chart below plots the S&P 500 against weekly MACD.

The green line is still well below the purple line as the histogram shows.

MACD is a momentum indicator so a delayed reaction is normal, however prior up trends were confirmed quicker than the current one.

The vertical black lines mark bullish MACD crossovers. The horizontal red lines mark the high prior to the correction.

The blue dots illustrate that the MACD generally turned positive before the S&P 500 (NYSEArca: SPY) surpassed its prior highs.

This isn’t the case this time around. Although the S&P 500 has come within four points of its prior high, MACD continues to lag.

It’s always difficult to extrapolate meaningful forward looking guidance from a backward looking indicator, but MACD suggests the rally may not (yet?) be as strong as it needs to be to break out.

In addition, we note that MACD at the S&P’s January high stayed below the MACD reading at the May S&P high. This is another potentially bearish divergence.

If you’ve read my recent articles, you notice that there are enough bearish indicators to paint a bearish picture  and enough bullish indicators to paint a bullish one.

Am I playing both sides of the market? No. But it is important to be aware of all the facts and make an educated decision.

Sometimes the most obvious path is the right path. So far, the S&P 500 has followed the Profit Radar Reports proposed outlook (rally from the 1,730s to the 1,830s) so it deserves the benefit of doubt until proven wrong.

If you read the articles above, you’ll see that there is a clear level of ruin for this outlook and one specific outcome that will prove it correct. Here are more details: The Last Hope for Bears

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500 technical analysis, 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.

How to Turn The S&P/Case-Shiller Home Price Index into a Forward-Looking Indicator

The S&P/Case-Shiller Home Price Index of 20 big metropolitan areas rose a seasonally adjusted 1.1% from February to March and 10.9% year-over-year. This is the largest monthly gain since April 2006. This is great news, but ‘old’ news. What happened in March doesn’t tell us about the future. Here’s what can.

The largest gain for home prices in seven years is reason for cheer, but will the trend continue? Is it possible to turn the lagging S&P/Case-Shiller Home Price Index into a leading indicator for the real estate market?

The S&P/Case-Shiller Home Price Index is one of the most popular and most widely accepted gauges for real estate prices, but it is not a leading (as in projecting future prices) indicator.

In fact, the S&P/Case-Shiller Home Price Index is calculated using a three-month moving average (the averaging methodology is used to offset delays that may occur in the flow of sales price data) and is published with a two-month lag.

Today’s brand new S&P/Case-Shiller Home Price Index readings covers data from January – March 2013. So data is delayed and represents a snapshot of the past with no influence on future prices. It’s a classic lagging index.

How can you turn a lagging index into a leading index?

One method we’ve used successfully in the past is to ‘enhance’ the rear-view mirror message of the S&P/Case-Shiller Home Price Index with the predictive qualities of lumber prices.

This is not an exact science, but lumber prices tend to set the rhythm for home prices. This makes sense; after all lumber is the key ingredient for every residence.

Previous analysis of this correlation in October 2012 and March 2013 suggested higher real estate prices.

The chart below plots the price of lumber against the PHLX Housing sector. Lumber prices are set forward by 14-months to express the ‘crystal ball-like’ properties of lumber.

Lumber prices soared 53% from September 2012 to March 2013. The strong real estate performance is therefore no surprise and according to lumber, more gains are ahead for housing.

But over the last two months lumber prices have dropped 32%.

Lumber’s wild 53% gain and 32% drop are not yet reflected by the housing sector index.

The correlation between lumber and the housing sector is not perfect, but it should cause some ripples for the housing market soon.

It will be interesting to see if lumber prices peaked for good or just entered a correction. A permanent peak for lumber could translate into a 2014 top for real estate and opportunities for real estate ETF investors.