SP500 V the AUDJPY

An ex-colleague asked me yesterday why I have not committed to the short-side of the market considering my recent bearish posts, I responded by showing him that I have also had a number of bullish posts and arguments too, and that I considered both have their merits right now even if I do not trust the upside. He countered with his claim that the upside just did not make any sense in his book as it was totally irrational. -- He walked straight into that one really; --  cue John Maynard Keynes famous quote:  'Markets can stay irrational longer than you can remain solvent'.  - He politely backed down.....  

Today's post is going to look at the relationship of the SP500 and the AUDJPY fx cross. The AUDJPY fx cross has been one of my favourite barometers of risk appetite, its moves have been very closely correlated with moves in broader US equities for some time now. The first chart shows this close correlation has existed since around 2003 now. There have been some periods of directional divergence though these have been few and far between, the most obvious being H1 2008, though this eventually came back into line.

Over the course of this year the directional (not magnitude) correlation has remained strong. This can be seen on the daily chart below. However over the past two weeks there has been a strong divergence between the two. The AUDJPY has remained very benign lately moving in a tight sideways band, meantime the SP500 has gone from strength to strength. I assume that what is happening is an adjustment due to expectations of QE2, however if this is not the case, then should the AUDJPY fail to break out sharply to the upside soon, then perhaps the SP500 may realign itself with a sharp correction (one to watch I suppose).

The next chart shows the AUDJPY on its own with the MACD over the past year. I have highlighted the current sideways consolidation and the 2 prior similar consolidations from this year, together with their MACD indicators. There is no guarantee that just because we have 2 previous similar patterns, that a third similar pattern will produce the same result, however I think it is worthy of consideration. Note; the strongest similarity is with April this year. - I would point out that there is no hard and fast rule as to which way these sideways correlation typically breakout (absent of a an extended prior trend), or how long they can last.

I do not have any sort of recommendation based on the above, but I do think it is something else to keep an eye on in trying to gain an understanding of the bigger underlying picture.