The Yen, Flows, and the Nikkei

The dollar often appears to be confined to a trading range against the yen. This was the case from last December through mid-May.  When it looks like it is trending, like from mid-May through the end of last week, it often is moving from one range to another.  

Typically what happens is that initially the new range is overshot a bit.   The dollar reached almost JPY126 last week after having bottomed just below JPY119.00 in mid-May.  It has closed only once above JPY125, and that was at the end of last week.  It has slipped about 1% already this week.  

Technical indicators suggest some near-term caution is in order.  The RSI did not confirm last week's new high, leaving a potential bearish divergence in its wake.    The MACD is set to turn down.   A shelf has been built since late May in the JPY123.50-80 area.  If that floor is violated, there is scope for another yen decline that would bring it into the JPY122.50-60 area.  This corresponds with a Fibonacci retracement objective (~JPY122.65) and the 20-day moving average (~JPY122.55).

Japan's Government Pension Investment Fund (GPIF) and others pension funds are well into a significant portfolio adjustment.  They are diversifying away from Japanese government bonds toward equities and international assets.  GPIF announced last October that it would reduce domestic debt to 35% of its portfolio, and boost equities to 50%.  As of the end of last year, Japanese bonds accounted for 43% of its portfolio, down from 48% at the end of September 2014.  Local and foreign stocks increased to 20% each.   

In Q1 15, Japanese investors bought JPY5.64 trillion of foreign bonds.  This is the most for any quarter since Q3 2012.   In April, at the start of the new fiscal year, Japanese investors sold JPY2.17 trillion of foreign bonds, which is almost half of the bonds it bought in Q1.

April did not only mark the beginning of Japan's new fiscal year, but it also seemed to have been the climax of the big rally in European bonds.  Japanese investors were heavy sellers of European bonds in April.  They sold JPY1.32 trillion of German bunds (most since March 2014) and JPY919 bln of French bonds (most since at least 1995 when the time series began).  Japanese investors also sold JPY245 bln of Austrian bonds.  

Part of the sales of these euro-denominated bonds was offset with the purchase of Italian bonds (JPY146 bln), Belgian bonds (JPY115 bln) and Finnish bonds (JPY76 bln).  April was the third consecutive month that Japanese investors were net buyers of Italian bonds (~JPY600 bln). 

Japanese investors snapped a four-month selling spree of selling UK debt.  From last December through March, Japanese investors sold a net JPY707 bln of UK debt.  In April, they bought almost JPY158 bln.  

Japanese investors were heavy sellers of Chinese bonds in April.  The JPY16.7 bln in net sales may not seem like much, but it is by easily the most sold since the time series began in 2000.  The previous record was the JPY7 bln sold in October 2014.  Japanese investors have sold Chinese bonds in four of the past seven months.  The 12-month average has been one of small net sales since last November. 

Japanese investors were big buyers of US bonds and notes in Q1.  Their nearly JPY3.7 trillion of purchases was the most for a quarter since Q3 13.  They pared their holdings in April, selling almost JPY434 bln.  It was the first monthly sales of the year. 

While Japanese investors were net sellers of foreign bonds, they continued to buy foreign equities.  Last year, they bought an average of JPY847.6 a month.  This year's average is almost JPY2 trillion.  In April, they bought about JPY1.77 trillion  

The country/regional breakdowns do not appear to be able to be reconciled with the aggregate figures, but here the highlights as we understand them. Japanese investors were small buyers of European stocks last year, average less than JPY18 bln a month.  This year, the average has shot up to JPY405 bln.   A similar pattern is evident for US shares.  Last year, Japanese investors bought an average of JPY40.5 bln US equities a month.  This year  they are averaging near JPY400 bln a month.   Japanese investors have doubled their purchases of ASEAN equities from about JPY52 bln a month in 2014 to almost JPY105 bln so far this year.  

The Bank of Japan is buying Japanese shares as part of its QE program.  Japanese pension funds are also believed to be buying domestic equities.  The 15.1% rise in the Nikkei, this year includes the 2.2% pullback over the past five sessions.  In addition, the depreciation of the yen has fattened overseas earnings when converted back to yen.  Japanese companies, awash with cash have also begun buying back their own shares. 

Some have suggested the operative investment strategy is “do not fight the central banks”.  So far, in terms of Japanese stock this may have been a helpful guide.  However, the Nikkei gapped lower earlier today.  The gap is found between yesterday's low (20359) and today's high (20332).   We have found the gaps in the Nikkei to be an important technical indicator.   If the gap is not closed in the near-term (tomorrow), which seems unlikely, it will likely be what technicians regard as a break away gap, suggest further losses in the period ahead.  The daily technical indicators are warning of such a setback.   Indeed a break of today's lows (20095) would violate this year's uptrend line.   The initial downside target is in the 19500-19600 range. 

Over the past sixty sessions, the Nikkei and dollar-yen are only slightly positive correlated on a percent change basis.   However, simply in terms of direction, the dollar-yen correlation with the Nikkei is near 0.66 and rising.  It briefly was negative in late May.  Over last 100 sessions, the dollar and Nikkei move in the same direction about 73% of the time.  Over the past 30 sessions, the two have moved in the same direction 80% of the time.

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