Carry trade plus yield and risk hunting
The chart shows the correlation between the Aussie/Yen exchange rate and the All Ordinaries. The black line is the Aussie/Yen exchange rate. It shows the Australian dollar breaking out to new highs against the Yen. In fact, the 91.6 level is the highest since 2008.
The green line is the All Ordinaries. In early 2012, the All Ords did not follow the exchange rate higher. This time, it looks like Australian stocks are tracking the exchange rate. This makes sense if you believe the US fiscal deal is a green light for the ‘risk trade‘.
The ‘risk trade’ is where investors are bullish enough to borrow cheap in a currency like the US dollar or the Japanese Yen and then use the borrowed money to buy higher yielding assets or currencies. With central banks in Japan and the US committed to keeping interest rates low (seemingly forever), this gives traders and investors an apparently easy way to rack up big first quarter gains without the risk of some political wild card shocking markets.
There are some contradictory technical indicators on the chart, though. The 100-day moving average of the AUD/JPY exchange rate has recently crossed the 200-day moving average. Technicians would normally see this is a bullish sign. And of course, any time a price breaks out to a new high, you have to take notice.
But contradicting the bullish indicator is the Relative Strength Index (RSI) at the top of the chart. Any time the RSI trades at or above 70, a security tends to be overbought. You can see that in the past, when the AUD/JPY RSI is over 70, it usually precedes a decline (a weaker Aussie). The RSI is currently at 80.
However I’m not interested in this relationship because I’m interested in buy/sell levels on currencies. What’s interesting is what it means for demand for Australian stocks. Take a look at the table below. I compiled it near the end of 2012 to look at how the top ten stocks by market capitalisation, performed in 2012, and the dividend yield on each stock.
Aussie yields a magnet to global capital flows?
What does the table above have to do with the AUD/JPY chart earlier?
To me it suggests that high-yielding Aussie blue chip stocks have become a way to for traders to play the ‘risk trade’. With commodities out of favour (BHP and RIO having average years in terms of capital gains) global investors are still keen on exposure to the strong Aussie dollar. They’re just getting that exposure in more conventional ways, through the bank stocks and big blue chips that also pay a dividend, like Telstra and Wesfarmers.
It will be interesting to see if the weak Yen or the weak US dollar is the bigger driver of foreign capital into Australia. I mention that because the US dollar seems unlikely to strengthen against the Aussie if Australia is seen as part of the ‘risk trade’. And in any event, the US fiscal situation and debt ceiling will put pressure on the USD for most of the next two months (at least you’d think so).
Yet it’s not all good news for Australia. Capital flows may be pushing up blue chip stocks and the Australian dollar. But the strong currency is nullifying the effect of interest rate cuts from the Reserve Bank of Australia. And the RBA has plenty to worry about already.
Dan Denning,
for Money Morning Australia
P.S. Your regular edition of Money Weekend will return next week. In the meantime, enjoy today’s special instalment showing why Australian stocks are powering ahead. And if you want to read the opposing point of view, or why 2013 could end up being quite bearish for ‘risk’, have a look at Exter’s Prophecy.
