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Looking for a Pause in the Nikkei

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A good rule of thumb is to analyze the depth of the base and add to it the distance to the breakout level.

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"The secret of success is the consistency to pursue" -- Harry F. Banks

Good Monday to all. I hope your Super Bowl Sunday was as fun and exciting as ours - now it's back to business. Last week's 'Jo' spoke about a potential downdraft in the Nasdaq 100 (NDX) following Google's (GOOG) earnings and the ever increasing volatility one company can have on the overall market. However, on that particular day the NDX pulled together some muster and managed to close higher on the day. That was certainly good news for the bulls. Nonetheless, with the release of Amazon's (AMZN) earnings on Friday, combined with both weak employment number (198K vs. 250K expected) and an increase in wage inflation, the market just couldn't hold and the very short-term trend / the 50-DMA (day moving average) was broken on all three sisters. As we mentioned in our previous work next potential support rests at 1,220 SPX; 1,600 NDX; and 10,600 INDU respectively). These all correspond to the 200-DMA as well.

However, this is not really our topic of discussion today. Given what has been transpiring within the U.S. equity markets for the last year – nothing – many investors have been searching for alternative places to put their dollars to work. One market which has been very exciting over the last year is the Nikkei. Once this market broke out of a long consolidating base at 12,200 in August of 2005 it has been on an absolute tear and currently sits around 16,700. The main reason I bring this up is because of the warning shot across the bow that happened two weeks ago with the scandal of Livedoor's CEO, Takafumi Horie. This company was one of Japan's largest internet companies – it now lies in ruins. This sent shockwaves through all the world markets with the Nikkei dropping over 6% in a two day period and the Dow fell 213 points.

Given the large number of our readers invested in this exchange, the debacle inherently drove me look at the technical position of the Nikkei market for any clues to the future action.

The graph below is a mega long-term chart of the Nikkei (dating back over 20-years). As you can see this market has been in a downtrend since early 1990 and has yet to climb back above; that's really today's topic. Once the market bottomed in 2003 at 7,600, not unlike the U.S. markets, it began building a large base with a neckline (resistance level) at 12,200. There are two main points which need to be made. First, when investing in a particular stock or index one must attempt to properly manage positions in part by deciding where to take profits (whether it is partial or full). One way to do this is to examine the size of the base. A good rule of thumb is to analyze the depth of the base and add to it the distance to the breakout level. This can help determine the next possible level of consolidation as a rule of thumb. The second point is to look for any larger corresponding trends which could confirm the first deduction.

I have done precisely that on the graph below. Interesting, eh?


The next step is to determine whether there are any other indications that the market may be topping on a shorter term basis. By looking at the daily chart below you can see some other road signs which add to the weight of evidence of a possible consolidation. Two weeks ago the short term trend was broken and has been re-tested this past week. Where the inherent danger lies is with the momentum. As the market has recently made a slightly higher high the stochastic oscillator has yet to confirm this high. This does not mean that it won't go higher, but it is something to keep your eye on. If the stochastic does not cross back above the 80% line and begins another downturn – confirmed by the fast stochastic (K %) crossing back through the slow stochastic (D %) – it will establish a notable divergence.

Given this backdrop, the probabilities lie with the Nikkei consolidating back down to its next support level around 14,500. Make no mistake, this is not a recommendation to go running for the woods or sell all your Japanese investments. It is solely a technical observation on the current position of this market.


Until next time…

KAT

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No positions in stocks mentioned.

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