It was the best of times, it was the worst of times…it was the age of easier monetary policy and, well, slightly tighter policy. While you may not have thought much about Charles Dickens since high school (or even then), I’m taking time out of the Steelers/Ravens game to debate whether Japan’s new round of Quantitative Easing should be renamed “Great Expectations.” Wednesday’s FOMC press release may have brought the much anticipated ending of QE3 and a lot of debate about the exclusion of the word “significant” but Japan stole the show in Friday. With the simultaneous decisions by two supposedly separate bodies to expand the total amount of quantitative easing in 2015 to around 15% of GDP while also lengthening duration and then the Government Pension Investment Fund finally deciding to shift its asset mix to a more equity heavy posture that FT calculates could result in nearly $200 billion being reinvested in domestic and foreign equities.
While more than a few prognosticators on Monday will tell you that the easy money has already been made, given the positive correlation between equity returns and quantitative easing in multiple markets, I think it’s worth investigating whether there’s the possibility for more room to run in Japan.
Let’s start by looking at the primary victims of QE programs, and as you can imagine, QE hasn’t been kind to the Yen now down over 6% in 2014, and back to levels last seen in the second half of 2008. While FXY might be oversold after Friday with a weekly RSI (14) score back to 26.21, it has been trapped beneath its 50 week moving average since 2013 and those Friday press releases won’t be adding any lift to the Yen anytime soon. But after years of little investor interest, only 4 funds targeting currency exposure are currently marketed.
Switching to equities, one of the strongest performers in the Japanese space this year is the WisdomTree Japan Hedged SmallCap Equity Fund which does appear to be overbought in the short-term with a big gap to fill between $31-$32 (DXJS) which besides having nearly 25% of its equity exposure in small-cap industrials that in theory should benefit the most from a weakened Yen offers hedged exposure to prevent further declines in the Yen from hitting your portfolio statement too hard. If you think the currency doesn’t matter, compare DXJS to its non-hedged equivalent the WisdomTree Japan SmallCap Dividend Fund (DFJ) up 1.78% YTD after Friday compared to 7.78% for DXJS.
With Japan having gone nuclear with its monetary policy, all eyes are now sure to shift towards one central bank with a contracting balance sheet and the ECB Governing Council which is meeting this week in Frankfurt and will feature Mario Draghi doing his best to convince you that the ECB will actually attempt something…at somepoint…someday. While consumer prices have ticked up slightly by .4% in October, core inflation remains significantly below the 2% threshold while EU unemployment remains high at 11.5%. While the ECB has been reluctant to put the pedal to the metal, I remember the old adage to “buy the rumor and sell the fact.” The only difference is that the ECB lacks the structure and decision making process to make quick decisions…hence the fact they’re still in this situation instead of keeping the recession in the rear view mirror.
As you can see above, the Euro appears to be stuck in a long-term descending wedge pattern as periods of Euro strength/dollar weakness appear to be shorter and shorter in duration and with far smaller peaks. Is it possible that a future QE announcement could help propel the Euro below the $118 level? On a more positive note, the historically positive correlation between the Euro and European stocks seems to have reversed as Euro weakness brings in buyers. Not surprising given the high current account surplus for the Eurozone as a whole…weaker Euro, stronger imports, could be a winning formula for EU leaders and how they have to sell it to their citizens.