The relationship between the stock market and the dollar is much more complicated than one would guess from reading the financial press. When both the stock market and the dollar are lower, many observers quickly conclude that foreign selling is the culprit. As Japan's fiscal year draws to a close at the end of this month, the conventional wisdom explains the dollar's approximately 5% slide and the weakness in the
Dow Jones Industrial Average
as repatriation by Japanese investors.
It is true that Japanese investors sold U.S. stocks in January, according to the most recent data. It is also true that a recent
survey found that Japanese fund managers are shifting away from U.S. shares and investing in their home market. The weighting of U.S. shares in Japanese portfolios is at the lowest level in four years.
However, let's put this data in proper context. First, when investing overseas, Japanese institutional investors have shown a clear and nearly overwhelming preference for fixed-income instruments over equities. Second, of foreign owners of U.S. stocks, Japanese investors have a minor stake.
data show Japanese investors bought almost $5.7 billion of U.S. shares last year, accounting for just 5% of all foreign purchases. In January, Japanese investors sold a little more than $1 billion worth of U.S. equities, according to
Ministry of Finance
data. Over the past three years, Japan has accounted for about 1% of all foreign flows into the U.S. stock market.
The same Reuters survey found that U.S.-based global fund managers also have reduced their exposure to U.S. shares. U.S. investors are cautiously increasing their exposure to foreign markets. After being net sellers of foreign stocks from H2 1998 through H1 1999, American investors turned net buyers in H2 '99 and anecdotal evidence suggests this has carried over into this year.
estimates that U.S.-based global and international mutual funds saw a net inflow of $8 billion in February after $6.3 billion in January.
One market that U.S. investors shied away from in January, however, was Japan's. Indeed, for the first time since September 1998, Americans were net sellers of Japanese shares. Europeans, on the other hand, were net buyers of Japanese stocks in January.
Preliminary data for February suggest foreigners as a whole bought around 859 billion yen (more than $8.1 billion) worth of Japanese shares after purchasing 52.8 billion (about $500 million) in January. Even though this pace seems to be higher than at the start of last year (foreigners bought 677 billion yen worth of Japanese shares in January-February 1999), the impact is mitigated by the fact that foreign investors do not have nearly the appetite for fixed-income investments in Japan.
Nearly half of the foreign equity purchases in February appears to be shifts out of Japanese bonds. The preliminary data estimate that foreigners sold 426.5 billion yen of Japanese bonds in February, after buying 547 billion yen of Japanese bonds in January. For the January-February period, foreign purchases of Japanese bonds totaled about 120 billion, down from 843 billion purchases in the same period last year.
As foreigners have been significant buyers of Japanese shares, accumulating about $100 billion worth last year, domestics have been happy to unload their holdings. Japanese banks, insurance companies, and private firms are engaging in a multiyear strategy of unwinding cross-shareholdings. For the fiscal year about to end, Japanese companies probably sold around 5.5 trillion yen in domestic shares. This follows sales of 3.6 trillion yen in FY 1998 and 1.8 trillion yen in FY 1997.
Japanese individuals sold about 4 trillion yen of their own shares in 1999, but have begun reinvesting this year. In the first two months of 2000, individuals in Japan invested approximately 900 billion yen into the domestic equities. Flows into trust funds (mutual funds) were estimated at 390 billion yen in the first eight weeks of the year after inflows totaled only 530 billion for all of last year.
As interesting as they may be, portfolio flows appear to have little explanatory and even less predictive power in the foreign exchange market. Because of hedging activity and local borrowing to finance local purchases, the demand for U.S. assets is not necessarily the demand for dollars. Also, portfolio flows are only one part of international capital flows. Foreign direct investment and bank positions are two other significant types of capital flows. In any event, remember, turnover in the foreign exchange market is estimated at around $1.5 trillion a day, it swamps cross-border transactions by a wide margin.
Even if one knew for certain that Japanese investors, for example, were buying or selling U.S. shares, not only would you still not have any insight into the behavior of the U.S. stock market, but you also wouldn't know whether to buy or sell the dollar.
Beware of the curve-fitting analysts searching for some simple relationship, often a correlation between the U.S. stock market and the dollar. Although I am sympathetic to the
(Keep It Simple, Stupid) approach, spurious correlations abound. Given the huge divergence not only between the Dow and the
, but also within the Nasdaq itself, such superficial analysis begs the question over what index to use. And given the divergence between the performance of the yen, euro and British pound, it begs the question of which dollar measure to use.
Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at