I have established a small short term position long USD and short JPY (Japanese Yen). This is ahead of the Bank of Japan meeting April 3-4, on the expectation that they will announce a more ambitious plan to devalue the yen than the market expects.

I believe this will occur because, in the current risk-on environment, the US Dollar has been sinking. I do not believe this will last. Equities are continuing to make all time highs, however, if stocks continue much higher, they will be entering overvalued territory. I believe the markets are getting ahead of themselves.

However, the theory of reflexivity would predict that this strength in stock prices would subsequently strengthen the economic fundamentals. An advancing stock market draws foreign and domestic capital and allows companies to issue their own stock at advantageous prices to fund acquisitions and organic growth. In such an environment, the risk-on environment may continue.

The reason I am not paying attention to the reflexive implications of a rising stock market is that the positive bias that would normally accompany such a move is not there. More and more, so-called experts are questioning whether the current economic strength can continue in the absence of the Fed’s monetary stimulus, which will be coming to an end this year. If the conclusion of the Fed’s program pulled out the legs from the market, we might end up with a “sell-in-May-and-go-away” type scenario.

The government’s sequestration lends further support to the “sell-in-May” hypothesis. Economic think tanks are reducing their estimates of the impact of sequestration. I think these estimates are short-sighted. The full effects of sequestration will only be felt later in the year, and I believe they will take the market by surprise. As a consequence, I believe the stock market will suffer a pullback sometime in the coming months. I am watching the markets closely for signs of technical weakness, so that I can make an opportunistic short.

A decreasing market would lead to a “risk-off” environment, in which the US Dollar would go higher. This, coupled with the Bank of Japan’s plans to devalue the yen, should propel the USD-JPY exchange rate much higher. To help matters, there was a doji reversal in the one-day charts last week. I have set a stop limit at the bottom of this reversal, near the 93.70 mark.