We recently rolled out a new gauge for the Euro and as it turns out a very similar structure also works for the Yen. The primary components are:
- Bond volatility
- Interest Rate Differentials
The second two components are the same as we have used in the Euro gauge except that trendiness applies to the Yen time series, not the Euro. The first component is somewhat like the opposite of what it is for the Euro. The Yen likes lower bond volatility because in some respects the Yen trades in sympathy with bonds. Lower volatility usually means stability or even lower yields. Investors will feel safer in the Yen at the same time they feel safer in bonds.
We have big tails in the distribution so one must be prepared to see a lot of readings <=5 and >=95. That’s OK, it makes it quite clear where the gauge stands. When the gauge is less than five the average daily return is $-209 versus an average of $-4.65 for the entire sample period. If the gauge is above 95 the average return is $185.
The blue line shows the movement of the Yen by itself since mid ’08. If we take the gauge and divide it by 50 we get an index that moves between zero and two. We can use that as a position size (allowing for fractional positions) and take a position every night. Our average position will be equal to one since the gauge average is 50.14 When the gauge hits zero we will have no position at all. We can see how our performance moves with the market but has reduced downside and higher upside beta – that’s our objective.
This is simply the difference between the two lines in the earlier chart. There are periods where it doesn’t add value. Those will occur when there are key factors driving the Yen that are not on our list such as political turmoil or tsunamis. We must be careful to switch off this filter/gauge when there are such periods and stops must be used in case we wake up to a tsunami – literally or figuratively.
On the whole, this is an excellent filter. There are few periods of nonperformance and it works well during both rising and falling markets. If you want more statistics on the data please email us.