Earlier this week, Japan announced that their GDP (gross domestic product) had declined again and the country is now in recession. The definition of recession is two consecutive quarters of negative GDP. Most economists were expecting the Japanese economy to show positive growth since they have been devaluing the Japanese Yen by an alarming rate. Unfortunately, the Japanese economy shank by 1.6 percent instead of growing by 3.0 percent which was expected by most economists. This news is not very encouraging for Japan and it should be viewed as a very bearish indicator for the global economy as well.
One of the main catalysts for the strong stock market in the United States has been a weak Japanese Yen. You see, the large financial institutions short (bet against) the Japanese Yen by buying the U.S. Dollar against against it, this is know as the yen carry trade. These large financial institutions then take the leveraged proceeds from this short trade and buy the S&P 500 Index. This is why the market will often rise when the U.S. Dollar trades higher. Remember, the weak yen is one of the key the reasons why the U.S. Dollar has been strengthening over the past couple of years. Prior to the Japanese money printing experiment the S&P 500 Index would only rally when the U.S. Dollar declined in value against the other leading currencies. The devaluing of the yen has actually allowed the U.S. Dollar and the S&P 500 Index to strengthen and trade higher simultaneously.
Currently, it seems that the stock market can continue to rally until the USD/JPY (U.S. Dollar vs Japanese Yen) currency pair starts to decline. Last week, the Bank of Japan (Japan’s central bank) announced that they were increasing their stimulus program ( more money printing). This news cause the Japanese Yen to plummet to fresh multi-year lows against the U.S. Dollar. The news simply rallied the stock markets in the United States to new highs. It seems that the stock markets only care about a weak and falling Japanese Yen, even the Japan recession news did not effect the U.S. markets.
Japans debt to GDP is now over 240 percent. This is more than double any European nation. We all remember what happened when Greece was reported to have over 120 percent debt to GDP, the country’s stock market went into free fall. We now have to look at Japan as the country that could sent the global stock markets into free-fall should an outright collapse occur. Now please understand, this could still be several years away, but when leading Japanese ADR’s (American Depository Reciepts) such as Toyota Motors Corp (NYSE:TM), Honda Motor Co., Ltd. (NYSE:HMC), Sony Corp (NYSE:SNE) are making lower highs on the charts instead of new highs it should be very alarming. After all, Japan is printing more money that any other central bank and the desired results are just not showing up. Brace yourselves, when the Japanese financial system goes the entire global financial system is likely to go with it.