Correlation between Stock Market and Currency

I had mentioned in my earlier post http://niftywhatcanhappen.blogspot.com/2009/11/stock-market-and-currency-movement.html that we would analyze how Deflation in Japan had an effect on the Japanese Currency Yen, so here it is.

The Japanese Nikkei traded at 2000 in 1971, at that time 30 Japanese Yen sufficed to buy 1 US Dollar, by 1990 the Japanese Nikkei went to trade at 40,000 but now you must be expecting that the 30 Japanese Yen invested could buy more than 1 US Dollar, contrary 158 Japanese Yen were required to buy 1 US Dollar, that means the theory that strong growth lead to strong returns on investment in stock markets which leads to strong currency are completely wrong, as when the Japanese stock market gave 2000% return on investment in the period between 1970 to 1990 for an foreign investor, the Japanese yen cut 500% from that investment, now when the Japanese Nikkei reached its life time high in 1990, the Japanese Yen too reached its lowest against the Dollar in 1990, When the Nikkei went on to trade at 15000 in 1994 i.e when it was losing more than 50% of its lifetime high, 84 Japanese Yen were enough to buy 1 US Dollar, i.e while the Nikkei was losing value, the appreciation in Japanese Yen saw to it that a foreign investor was loosing money at a smaller pace than the domestic investor, Cut to 2008 – 2009 when most of the Emerging Market Currencies are loosing there value against the US Dollar while the Stock Markets are appreciating, It is the Japanese Yen which has reached its 15 year high against the US Dollar while the Nikkei is taking drubbing.

Now let’s see the correlation between the Dow Jones with the US Dollar and Nikkei with the Yen. Dow Jones traded at close to 1000 in 1970 and by 1990 it traded at just 3000. But while the local investors in Japan can say that there Stock index gave more return on investment then their counterparts in United States (well that might also not stand true if real inflation adjusted return on investment is taken into consideration) this doesn’t stand true for the foreign investors because while in 1970 close to 70 US Dollars needed to be invested to buy 1 Japanese Nikkei (70*30 = 2000, the value of Nikkei), in 1990’s the number of US Dollars invested to buy 1 Japanese Nikkei stood at 250 (250*160 = 40,000) i.e in Dollar terms the Japanese Nikkei just appreciated 300% same as the US Dow Jones, so from an US investor perspective the return on investment which the Japanese Nikkei gave was the same as the Dow Jones in his own local markets was giving. Thus an investor doesn’t earn more money in investing in foreign assets as even if the foreign assets appreciate more than the local assets the inflation in the foreign country sees to it that the currency depreciates against the home country currency.