There was a bunch of humorous blarney on the news wires today.  So-called pundits were saying that the international stock markets were weak last night, because of the higher than expected Chinese GDP, which was up 11.1% in the first quarter of 2007.  International stocks fell everywhere in the last 24 hours.

Inflation was 3.3% in China.  This means that poorly run companies in China probably had 20% earnings growth, and good companies had 30% (or higher) earnings growth in the first quarter of 2007.

This is not bad, and is no reason for the market to correct.  The real culprit (which as usual the news sources missed) was that the Japanese yen rallied to 117.60 per U.S. dollar, and this set off fears that the Japanese yen carry trade is unwinding.  This combined with the fact that technicians looking at the charts see the yen setting up a head and shoulders bottom which could carry it back to the level it saw last year of 109 to the dollar.

Everyone remembers the global market pull back of May 2006 and there is fear that it will repeat in 2007.  Technicians may be right sometimes, but I do not see any reason for the yen carry trade to stop.  My friend Larry Jeddeloh has researched this, and has shown conclusively that the main players in the yen carry trade are Japanese households.  They sell yen to buy foreign currencies and improve their interest income, because bank deposits in Japanese yen pay a fraction of 1% per year.  So, Japanese households change their money from yen to, for example Australian dollars, and earn about 6% per year.  It is good for the Japanese households, and there is no reason for it to stop.  Even if interest rates rise in Japan from the current level, they will rise in other countries by a corresponding amount so the interest rate differential will continue.  Thus, we doubt that the yen will rally hugely in 2007.

We have noticed a very high correlation between a stronger yen and weaker stock and commodity markets everywhere.  So when the yen rallies, we plan to wait to buy stocks and commodities on the ensuing pullback.  We believe that we will be rewarded when the yen reverses itself.

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