Arbing The Nikkei-S&P Divergence
For all the talk about how the US and Japan are becoming identical, there remains a very distinct and visible way in which the two are still very much different: charting the S&P and the Nikkei shows that the two indices are now at the widest spreads in 2010, and the widest since November 2009, when we last proposed a convergence trade. With the two indices historically trading with a R2 of 0.90, the current spread of roughly 10% seems like a relatively easy way to pick up 10%, once the world realizes that "Japan vs the world" doesn't really work, and recoupling is once again the dominant regime. Which would mean that either deflation will once again set foot in the US pushing stocks at least 10% lower, or Japan will finally import some inflation, leading to an inverse and comparable rise in the Nikkei. Thus, we believe a short ES, long NKY trade is a sufficiently attractive arb at this point. Furthermore, this is the cheapest and easiest way to hedge what is becoming increasingly inevitable: that the BoJ will have no choice but to follow our own Fed down the rabbit hole of money printing.