Nikkei outperforming Australia

Nikkei to outperform 

Finally, after many months of Europe toying with markets, Eurozone leaders reluctantly decided to bail out Greece. Or at least that’s what they want people to believe – that this can’t continue, bailouts aren’t to be taken as standard, moral hazard etc etc. In reality, a bailout was always likely to happen, as the panic that would sweep through markets if they believe larger nations such as Italy wouldn’t receive funds would be crippling. They were lucky to get away with relatively minor reductions in future interest payments, though they’d have you believe they were tough enough to avoid real concessions that would create a bad precedent.

Regardless, others news such as the recent Bank of Japan stimulus and rising Australian dollar have created a more rational trade idea. Japan is a largely export driven economy, meaning the strength of the Yen has significantly weakened domestic earnings. The Australian economy suffers from the same problem, and the increasing demand for the high yielding Australian dollar (domestic rates sit at 4.25%) has hindered domestic earnings growth.

However, the Australian Reserve Bank’s reluctance to lower rates any further, combined with Bank of Japan initiatives to weaken their currency, should see Japanese earnings start to increase at a faster pace than their Australian counterparts. The relative outperformance of the Nikkei over the AXJO since the Bank of Japan's announcement last week can be seen here as well as on the chart below:

Trade Summary

The suggested trade is to be long the Nikkei and short the same amount of the Australian index in the next couple of months. The risk is that the demand for the safe haven Yen increases again, strengthening the Japanese Yen and offsetting the work of the Bank of Japan and reducing the incentives for the market to move higher (besides that of impending European doom). But in any risk off movement, the Australian market is a far higher beta play and being the market of choice to gain leverage to China’s growth story, it too should fall faster than a caravan from the Empire State Building.

If all goes well, the Nikkei will receive a short term boost relative to the Australian XJO as the currency effects flow through to analyst’s earnings forecasts. Inflation is never going to be an issue for Japan in the medium term, so they can stimulate the economy as much as they like, and things can’t get much worse. Just recently they announced that exports plummeted due to the stronger Yen, and imports rose sharply as the Japanese nuclear disaster meant that fuel is still being bought from overseas. As they say, the only way is up. Let’s hope that the same applies to our bank balances. 

In the pipeline: Copper due for a correction

Bullish on: Japanese Nikkei vs. Australian XJO (weakening Japanese Yen helps Nikkei, high Australian dollar hinders XJO)

Bearish on: Copper (inventories are spiking and China is done buying in the spot market), US 10yr T-Notes (yields underperformed S&P so far, correction due)

As always, please leave any comments or questions that you may have. If you are looking for a trading guide for beginners, try www.tradingpimm.blogspot.com.