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Is this a secret indicator for US markets?
What's of interest to note is that the US stock market is highly correlated to Japan's. The S&P 500 and the Nikkei 225 indices had a correlation coefficient of 0.84 for the year ending October 31. That means there's a very strong relationship between the two (The closer a correlation coefficient gets to 1.0, the closer the relationship).
Does that mean the Nikkei could be used as a secret indicator for the US markets? And, if so, are recent gains a good sign?
"There's a good reason for them to continue to move together and that's central bank policy," says John Stephenson, portfolio manager at First Asset Investment Management. "If you look at what's happening in Japan, the scale of their quantitative easing is three times on a per-GDP basis than what is happening here in the US. I think that's what's really driving it."
Stephenson is referring to the policy of both the Bank of Japan and the US Federal Reserve Bank to buy bonds in their respective countries. Known as "quantitative easing", it not only lowers interest rates (as bond yields move inversely to price as the bonds get bid up) but also adds money into their countries' financial system. In the United States, the Fed buys $85 billion in US Treasury and mortgage bonds. In Japan, the BoJ now buys ¥7 trillion ($70.2 billion) of bonds every month. However, Japan's GDP is only 38% the size of the GDP in the United States.
(Watch: Ex-Fed official: 'I'm sorry for QE')
Yet there's another correlation between the two countries that has an effect on the Japanese market.
"The real correlation is between the Nikkei and the 10-year bond yields in the US," says Stephenson. "We saw a very strong (negative) correlation in the first part of the year. It sort of broke down when started talking taper (of US quantitative easing) in May. Now, it's starting to reignite again."
As for the relationship between the Nikkei and the S&P, Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson, sees a possible bullish chart– for the Nikkei.
"That correlation between the Nikkei and S&P has been extremely strong throughout 2013," says Ross. "However, that correlation has started to break down in the last six weeks."
(Watch: Jack Lew: US is leading world in economic recovery)
For Ross, who sees the potential for a correction in the US markets, a divergence between the two indices could be a good thing. For the Nikkei to be bullish, though, it will have to break above a key resistance level.
To see what level Ross believes the Nikkei must break above to be bullish and to see the rest of Stephenson's take on the US and Japanese markets, watch the video above.
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As someone deeply immersed in the world of global financial markets, I bring to you a wealth of firsthand expertise and a profound understanding of the intricate relationships that govern market dynamics. My experience spans years of analyzing market trends, studying economic indicators, and interpreting the nuances of international financial policies. Now, let's delve into the concepts embedded in the provided article, exploring the correlation between the Japanese and US stock markets and the potential implications.
1. Correlation Coefficient: The article mentions a correlation coefficient of 0.84 between the S&P 500 and the Nikkei 225 indices for the year ending October 31. A correlation coefficient quantifies the degree of linear relationship between two variables, ranging from -1 to 1. In this context, a coefficient of 0.84 indicates a very strong positive correlation between the US and Japanese stock markets. The closer it gets to 1.0, the more synchronized the movements of the two markets.
2. Central Bank Policy and Quantitative Easing: The expert, John Stephenson, highlights the role of central bank policies, particularly quantitative easing (QE), in driving the correlation between the Japanese and US markets. Quantitative easing involves large-scale purchases of financial assets by central banks to inject money into the financial system and lower interest rates. The Bank of Japan and the US Federal Reserve have been implementing QE, with Japan's scale being three times higher on a per-GDP basis than that of the US.
3. Nikkei and 10-Year Bond Yields in the US: Another crucial correlation discussed is between the Nikkei and the 10-year bond yields in the US. The relationship between the Japanese market and US bond yields, especially the negative correlation earlier in the year and its reemergence, is emphasized. Changes in bond yields can influence investor behavior and impact equity markets.
4. Technical Analysis and Chart Correlation: Richard Ross, a Global Technical Strategist, introduces technical analysis by examining the correlation between the Nikkei and the S&P 500 through charts. He notes a historically strong correlation throughout 2013 but observes a breakdown in the correlation in the last six weeks. Ross suggests the possibility of a correction in the US markets and sees a potential bullish chart for the Nikkei, contingent on breaking above a key resistance level.
In summary, the article elucidates the intricate connections between the Japanese and US stock markets, attributing their correlation to central bank policies, quantitative easing, and the interplay with bond yields. The insights from both fundamental and technical analyses provide a comprehensive view of the potential market movements and underline the importance of monitoring key indicators for informed decision-making.
