Tags: 2007 | dollar | yen | Japan

It's the 2007 Bubble-Like Behavior All Over Again

Tuesday, 29 April 2014 01:03 PM Current | Bio | Archive

When the Netherlands' CPB Bureau for Economic Analysis released its World Trade Monitor data last week, the fact that volume of world trade declined 0.7 percent in February from the previous month, following a 0.2 percent rise in January, really gave me a wake-up call.

What's more, from February of last year to this February, world trade in volume only rose 2.93 percent, while world trade prices with unit values in dollars actually fell 1.78 percent.

Long-term investors should keep these weak warning signs of world trade in mind and watch out if these weak numbers will be confirmed or not in the next CPB releases. One thing is for sure, the worldwide recovery has not reached escape velocity yet. No, not by a long shot. Maybe the unabated widespread optimistic behavior is in fact more based on hopes than on facts, which is not a sustainable base to build on.

To me, there is no doubt we are witnessing widespread bubble-like behavior similar to what we saw in the first half of 2007 in equity, as well as in currency, markets.

When we take a look at the euro/dollar currency pair, we could easily be on our way to closing in to $1.40 per euro because, among other things, investors still continue their desperate chase for yield and therefore remain attracted by the relatively high(er) yields offered by euro area periphery government bonds while "implied volatility" has decreased to levels that indicate the next 12 months will be the quietest on record. Only time will tell if this bullishness with a lot of risk was justified or not. In my opinion, it's not.

In general, "implied volatility" increases when a market is bearish and decreases when a market is bullish, as has here been the case with the prices of the various euro area periphery government bonds.

The increase or decrease of the "implied volatility" is due to the common belief that bearish markets are more risky than bullish markets are. In addition to known factors such as market price, interest rate, expiration date and strike price, "implied volatility" is also used in calculating an option's premium.

But, let's come back for a moment to the price action of both 1) the Japanese Nikkei 225, which is similar to the Dow Jones Industrial Average, and 2) the dollar/Japanese yen currency pair, when between June 2006 and June 2007 the previously extremely strong bull market in the Nikkei 225 index had started to run out of steam. On June 22, 2007, the Nikkei 225 was doing its best to surpass its earlier posted highs that were about four months old, while the majority of international investors remained firmly bullish on and confident in Japanese equities. Then, about a month later, an aggressive break of the uptrend occurred, which marked the start of a long downtrend that would last for 15 months. On June 29, 2009, the index was at 18,138 and by March 31, 2009, it was at 8,109, which represented a drop of about 55 percent.

In a somewhat similar fashion, but of course much smaller, we have the period that started in April of last year, which has been marked by steadily declining upward momentum in the Nikkei 225. It has taken seven months for the index to move back through its May 2013 high, albeit only briefly, before the index began rapidly retreating from its fresh highs and renewed its decline during the opening weeks of this year. Since then it has continued to struggle unsuccessfully to gain any renewed upward momentum.

While the Nikkei 225 closed on Dec. 30 at 16,291 and now is valued at 14,288, international investors have remained bullish on Japanese equities.

Interestingly the dollar/yen currency pair has shown a very similar pattern of behavior and also seems to be repeating what we saw in 2007, whereby fresh highs in the trend have been extremely hard to hold on to as any fresh sign of upward momentum has continuously ebbed away, although a well-developed trading range has established itself so far.

It must also be said we have seen the gap between 10-year U.S. and 10-year Japanese government paper narrowing, which has resulted in diminished selling pressure on the Japanese yen. While the relationship between this yield gap and the performance of the dollar/yen currency pair has broken down occasionally during the course of the past decade and as most recently during last year's "taper tantrum," it has come right back into play since August of last year.

It should come as no surprise that the renewed downward pressure on U.S. 10-year yields (higher prices for the U.S. Treasurys) has had a direct impact on the dollar/yen currency pair quotation. Interestingly, when looking at the performance during a 14-month time span, the old price range between the two currencies is met again and stands just above 101.50 yen per dollar.

Finally, one more point that perfectly echoes the "infamous" summer of 2007 (sorry, but it's purely technical) is that the cost of one-month at-the-money-forward implied has once again come down and is now in the 6.16 percent more-or-less zone.

Long-term investors should take notice the Dow Jones Industrial Average was at 13,893 on Sept. 28, 2007, and moved thereafter down to 7,608 on March 31, 2009, a drop of approximately 45 percent in 18 months.

I have learned during my lifetime that history doesn't repeat itself, but it often rhymes. To me, today, there are too many indications we could be bound for a severe correction that could be something similar to what started at the end of the summer of 2007 because there is, among many other things, way too much optimism in the markets.

I could be wrong, but with all the indications I accumulate, I think we are closing in on an experience we could call 2007 Part 2, which in case that would happen should present a boatload of once-in-a-lifetime buying opportunities for those who are cash-rich at that moment in time.

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I think we are closing in on an experience we could call 2007 Part 2, which in case that would happen should present a boatload of once-in-a-lifetime buying opportunities for those who are cash-rich at that moment in time.
2007, dollar, yen, Japan
Tuesday, 29 April 2014 01:03 PM
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