The Japanese Yen is back to alarming levels.
The beginning of the earning season is not the only reason for the pull back in the stock market in Japan. The rapid appreciation of the Japanese currency versus the dollar and the euro is also going to weight on the possible recovery of the market. If you remember, the Yen touched its lowest levels in many years last March at the worst of the financial crisis. It was more or less expected to rebound at that point since the move was more due increasing fear than real economic. But now that we are moving closer to the March level, can we expect another strong rebound of the yen?
As much as it is fairly possible to predict what foreign exchange rates might do in the medium to long term, it is very difficult to know exactly which direction currencies will take in the short term. The volatility, the importance of hedge funds and speculators in Forex future markets are few of many reasons I find very difficult to give an opinion for currency moves for short term trading. I have added couple charts below where you can see the strong appreciation of the Yen in the recent months.
I believe the coming months will be difficult for the exports related companies as the Yen will probably appreciate. Investors are well aware that foreign exchange rates levels are very important when looking at exports related stock’s valuation in Japan. For these companies, most of their transaction is in US Dollar or Euro and any important appreciation of the Japanese currency can drive down earnings significantly. The earning season that just kicked off yesterday in the US with Alcoa is going to be critical.
A disappointing earning season would certainly lead analysts and economists to revise down their forecast for the next 6 to 12 months. A slower recovery of the economy would also certainly push the US and European governments to come up with more stimulus plans. Already there are rumours of a second stimulus plan in the US and France wants to raise another €10 billion in sovereign debt in 2010, which would increase its Debt/GDP ratio. Spain is facing the worst economic crisis in many decades and would certainly need more government spending to help its industries to stay afloat, especially in the construction sector.
I am not saying here that the Japanese economy is in better shape as its Debt/GDP ratio, seen in the chart below, is already much higher than any other developed countries. On top of that the country has been using a quantitative easing monetary strategy for quite some time and it does not have anymore margin to use monetary policy. However, it is possible that earnings might be slightly better in Japan as many companies are expected to have taken advantage of the strong recovery of the Chinese economy.
All in all, I believe the Japanese currency is going to appreciate more in the coming months as earnings in the US and in Europe should disappoint investors. The long and slow recovery of the economy is going to surprise many investors and as a result will hurt the US and European currencies.
On the other hand when looking at the $/€ exchange rate, I think the Euro is ready for a dive as the BCE might lower even more its interest rate. One more issue European countries are facing is the unemployment. Companies kept their workforce untouched for as long as they could but the slowing recovery of the economy should push them to lay off more people in the coming months. The stricter laws in Europe made it very difficult for companies to cut cost rapidly and I think it is going to hurt many European companies while US companies have already cleaned up their workforce. It is evident that topline growth is very difficult today and the only way to survive is in cutting cost and especially fixed cost like SG&A.
The upcoming weeks will be very interesting and important for the Japanese stock market. I hope to be wrong in my expectation, it would be much better for the stock market … but sometimes it is better to talk about what could go wrong than what might go well!
Have a good weekend