The First Half of the Short Yen / Long Japanese Equities Trade is Still On

Two weeks ago, I asked if the short yen / long Japanese stocks trade was over.   It appears that, indeed, it is.

The Nikkei crashed by over 6% on Thursday, pushing it well into bear market territory.  It’s now down by more than a quarter from its recent highs.

And the yen?  It has rallied and is now at a three-month high.

What’s going on here?  Has the market lost faith in Abenomics?

We shouldn’t draw too hard of conclusions here.  First and foremost, we have to remember that the Nikkei had doubled over the course of just half a year and that the yen had lost roughly a quarter of its value relative to the dollar over the same timeframe.  Some of the “hot money” that had pushed this trade to such extremes has been taken off the table.  Traders had made a killing, and it was time to take profits.

As for Abenomics, I don’t think it is a case of the market losing faith in it because I don’t believe that the Smart Money ever truly believed in it to begin with.  “Successfully” igniting inflation risks destabilizing Japan’s sleepy bond market…which in turn risks turning the orderly decline of the yen into a hyperinflationary rout.  No one in their right mind would want to be a long-term holder of Japanese equities given the risk of a credit market meltdown.  Sure, Japanese equities are cheap.  But they’re not cheap enough for that kind of risk.

The Smart Money saw a great opportunity for a short-term trade, and they took it.

But what can we expect going forward?

I expect a lot of volatile noise from the Japanese equities market that will be hard to play, long or short.  But I believe the second half of the trade—shorting the yen—still has life left in it.

The easiest way to short the yen is via the ETF market: the Proshares UltraShort Yen Fund ($YCS).

Be careful here.  YCS has been in free fall since late May, and you don’t want to catch a falling knife here.  I would recommend starting small—with, perhaps, 20% of the allocation you want to eventually have invested in this trade—and average your way in over the course of the next several weeks.

If I am right about Japan having a capital markets meltdown , the yen has a lot further to fall.

Of course, the day of reckoning could be postponed due to coordinated central bank action, or I could simply be wrong.  A lot of very smart macro traders have bet big on a Japan blowup in recent years only to be disappointed. To play it safe, use something along the lines of a 10% stop loss.

Disclosures: Sizemore Capital has no current position in any security mentioned.   This article first appeared on TraderPlanet.

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