We first divided the Nikkei by the DJIA and plotted the resultant series (the thin line, LHS, on the graph above). A rising graph (as for the period Jan '86 to Jan '90) shows the Nikkei outperforming the Dow and vice versa. Currently the series is flat, but at the lowest level in the period studied with the reading at 1.59. We have worked out the following possible combinations of the Nikkei and the Dow (looking a few months into the future). The graph hints at continued stability for the next 2-3 months. As such, neither of the last two possibilities looks convincing. The study reflects the large Equilibrium prevailing in the market.

Yen/ $
We then plotted Yen/$ (inverted rate) on the same graph (thick line, RHS) to see if there is any co-relation between the two. We found alternating periods of positive and negative co-relation, as marked out in the graph above. We can see, however, that periods when the Nikkei has outperformed the Dow (82 to 89 and between 92-94) have been accompanied by a strengthening of the Yen. In fact this is the argument doing the rounds in the market - the Yen is strengthening because the Nikkei looks better than the Dow.

Our Reading
We think that the current Yen strength may be a little exaggerated. The forex market may have read a little more into the "foreigners investing in Japan" story than may be warranted. While the Nikkei/Dow index is largely stable, the Yen has strengthened dramatically (almost as dramatically as the sub-100 movement in 1995) over the last 12 months. Our best call therefore would be for a period (1-2 months) of range trading for $-Yen between 105 and 115 and an eventual weakening of the Yen towards 125 over a 12 month period. In short, we look for continued Equilibrium at these levels for some time, before eventual Dollar strength.

Real Interest Rates
Traditionally, long-term movements in exchange rates are more greatly influenced by movements in relative Real Interest rates of the countries concerned. Currently the market is focused on Equity flows. We shall examine the Real Interest scenario in a separate study.