The Japanese Yen plays a unique role in the global financial markets: It’s the funding currency of choice for hedge funds and other big time institutional traders. A combination of ultra-low interest rates and Japan’s preference for a weak currency makes it the ideal currency in which to borrow.

Borrowing money in a weak, low-interest currency to fund investments in countries in which currencies are strengthening and yields are high is the classic “carry trade” strategy. And it works, until it doesn’t. Once traders start unwinding their positions, the situation is vulnerable to a stampede as everyone reverses at the same time.

This long preamble sets the context for an important development that’s happened over the last few weeks: The Japanese Yen has been on a tear, rising 9.1% since May to return to highs reached in 2008 and 2009. And because of the fears that a strong currency will hit Japan’s exporters, the Tokyo Nikkei Average is down 11.4%.

So why is this good for U.S. stocks? Shouldn’t a strong Yen and the weak Nikkei be a negative? After all, a strong yen represents risk aversion, fear, and the unwinding of carry trade positions.

Actually, the evidence suggests that once people expect the yen’s strength to continue, a stock market surge is likely to follow. According to Jason Goepfert from SentimenTrader, when optimism about the yen reaches high levels, stocks tend to move higher over the next four weeks. The analysis is based on the number of net-long yen futures positions held by large speculators. Right now, these traders are holding one of their largest net-long positions in the contract’s history.

Since 1991, when the net-long yen futures position of large speculators hit similar levels, the S&P 500 moved higher 15 out of 15 times. The most recent occurrence was in November 2009. The medium return was 2%.

But here’s where things get interesting. The largest one-month return was 15% back in October 1998 in the wake of the Asian Financial Crisis. There are more than a few similarities between that pullback and the current declined which was caused by the European debt crisis. A large magnitude pullback came within the context of an expanding economy, plenty of liquidity, and healthy stock market breadth.

I believe a similarly large rally could unfold into August. And I’m looking for emerging market stocks to continue to lead the way higher. The iShares Emerging Markets (NYSE: EEM) is the best choice for conservative investors; for the gamblers out there, be sure to check out the Direxion 3x Daily Emerging Market Bull (NYSE: EDC

), which returns three times the daily return of the MSCI Emerging Markets Index.

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