• USDJPY suggests the Japanese NIKKEI (JAP225 on xStation5) could be overvalued
  • P/E ratio points to massive overvaluation of the JAP225
  • The Japanese index is on the verge of a larger move downwards

There is nothing new that the JAP225 is inversely correlated with the USDJPY currency pair. It stems mostly from the fact that more capital flows out rather than into the country. In short, Japanese investors own more foreign assets than foreign investors own of Japanese assets. Furthermore, the yen is treated as a so-called safe haven asset, hence it tends to gain when stocks decline all around the world.

Being already acquainted with the above-mentioned relationship let’s move to a technical analysis. At first, there is no doubt that today’s session brought a massive risk-off mode on the back of another ballistic missile test carried out by North Korea. In effect, the Japanese currency got a boost while stocks in Europe and Asia plunged. Nevertheless, much larger declines were seen in the old continent than in Japan. It could come from the fact that Japanese investors might get back home when a rout across foreign equity markets deepens.

link do file download linkThe JAP225 is on the verge of an extended pullback being close to a 50% retracement of this year’s rally. Source: xStation5

Given a correlation between the USDJPY and the JAP225 a noticeable discrepancy has been drawn lately. Thus, if sellers are able to break a 50% retracement durably, it could prompt their to increase their involvement into the market. Assuming that upside pressure on the JPY could persist chiefly on the back of political tensions while the greenback will remain on the back foot, a breakout of that level could take place.

link do file download linkThe P/E ratio for the JAP225 has tumbled while a decrease of the index has been much more contained. Source: Bloomberg

Looking at the most common equity valuation metric one could spot that the JAP225 looks as if it would be by far too high. If the index is to catch up its fundamental indicator, it would mean a hefty sell-off. To sum up, even as the index is overvalued against the P/E ratio, the same scenario could be perceived at other markets such as DAX or SP500, thus until there is a clear breakout of the above-mentioned technical level it has to be cautious.