The S&P 500 index may be setting up nicely for another big move lower. Presently it is correcting higher; possibly it’s that Joker—Mr. Market—sucking in more victims who listen to the buy and hold guys leading the bull charge again—thank you financial TV. Inherent in my primary view, the top is in place in the S&P and the trend is now down (simple Dow Theory is the confirming indicator—see page 4). If this stylized view plays out, it sets up the potential for a very nice currency trade—short the Australian dollar and long the Japanese yen (AUD/JPY cross page three).
On a big break in stocks the dollar should get a risk bid against most of the pairs. But there is a potential for a dramatic fall when pairing the yen against the Aussie. Why? Because the Japanese yen tends to remain well supported and often rallies against the US dollar in times of global “risk off.” And the Aussie is the major pair most leveraged to growth; the assumption here is recognition global growth in the proverbial toilet, and the central bank can do little to change that situation, triggering a stock market selloff is especially bad for Australia given China’s troubles. The correlation between AUD/JPY and the S&P can been seen on page 3.
S&P 500 Futures versus AUD/JPY Daily: Note the sharp fall in the pair during the credit crunch crisis. AUD/JPY fell from 103 to 55 (-46%) in just over two months (65 days to be exact). That is massive. I realize it is never easy to catch a trade such as that from the beginning, and ride to the end, but even if you captured only a part of that move you would have been a very happy camper. Granted, we may not see price action that drastic, but otherwise the setup seems to be in place. The risk of course is if the Japanese yen acts differently than it has in the recent past on major global risk off (some type of massive liquidity move from the BOJ). But I don’t suspect it will.