The central market story of 2013 has been the new record highs posted in the U.S. benchmark indices. The S&P 500 (SPY) is in route to the mid 1600s and the Dow Jones Industrials, played through the SPDR Dow Jones Industrial Average ETF (DIA), now show an established foothold above the 15,000 handle. While the upward momentum is encouraging for global markets, there are important arguments for why this bull move has yet to run its course. Near term, however, overbought conditions suggest that stocks are vulnerable to downside risks. So how can investors play these moves? Are stocks the only option?
Currency traders with a firm understanding of market correlations know that a strong potential upside in stock markets suggests positive moves in high-yielding currencies (and bearish scenarios for low yielders such as the Japanese yen). Commonly used vehicles in the high-yield space include the Australian and New Zealand dollars. The combination of all these factors suggest significant upside potential in currency pairs like the AUD/JPY and NZD/JPY. Translating these plays to ETFs means potential long positions in instruments like the CurrencyShares Australian Dollar Trust (FXA). By contrast, this would translate to a selling bias in ETFs like the CurrencyShares Japanese Yen Trust (FXY).
Under-Valued Stock Arguments
Looking at stock values from an historical perspective, its relatively easy to see continued upside. Using the tech-boom stock rally in the 1990s as a frame of reference, stocks are trading at a relative discount of nearly 30%. In the late 1990s, the S&P 500 was at nearly 26 times earnings at the peak. Today, the S&P is trading closer to 19 times earnings. So, while we are seeing many arguments that the market is forming a major bubble, when we look at things from the larger perspective, these arguments hold less weight.
Given these arguments, it makes sense to look at correlated assets that are now positioned for further upside. Positive moves in stocks tends to be a supportive factor for high-yielding currencies, so when we see significant uptrend momentum in the S&P 500, significant conclusions can be drawn:
With the S&P 500 actually breaking to the topside in its uptrend channel, it is clear that market momentum rests in the positive direction. But as stocks deviate sharply from their short-term averages it makes more sense to look at currencies as an alternative vehicle for playing the positive sentiment present in the market.
Since positive stock values suggest upside for the Australian dollar and weakness in the Japanese yen, traders should look for value in the AUD/JPY pair as a basis for entering into new positions. From a price perspective, this looks set to establish itself near the 100 psychological level. Once this level trades, look for new exposure to high-yielding assets in forex markets as a means for playing the bull trend in stock markets.