Thursday, September 09, 2010

What is driving the stock market these days?

I’ve noticed a strong correlation between the daily changes in the Dow Jones Industrial Average (DJIA) and and the changes (against the dollar)  in high yielding currencies used in the carry trade. (The carry trade is the practice of borrowing money in a low yielding currency like the US dollar or Japanese yen and investing it in a high yielding currency.)

The correlation is not true for low yielding currencies like the Japanese yen. To see the correlations visit the following links.

Australian Dollar

New Zealand Dollar

Japanese Yen

The first two are often used on the high side of the carry trade. When these currencies follow the market up it means the dollar is depreciating against these currencies, countering a portion of the dollar gains on the stocks.

The reason this is at all of interest to investors is that, if the correlation is strong, it suggests that the market is being driven largely by very large investors like big banks, hedge funds, institutions, etc, because the great mass of small investors seldom use the carry trade. It raises a further question regarding whether the coordination of these large investors is a form of market manipulation. It would be possible for large investors with real time trading and front running tools and acting a coordinated way to move the stock market and currency market up and down to continuously skim profits from investors not so equipped. A low correlation between the carry trade currency changes and the DJIA would suggest that this is not happening.

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