Nikkei Cratering But...

Much has been said lately about a collapse in the Japanese economy based on their high levels of debt relative to GDP and their relatively stalled out revenues to service this debt. These thoughts tend to arrive each time the Nikkei 225 Index is having issues and the Yen is strong. The thought is simple: A falling stock market locally will hurt the banks that are holding equities in their portfolio and a rising Yen will kill of exports thus hurting the trade balance and the level of revenue to service the debt. Thus the result is another banking crisis and sovereign default - at least that is what is being speculated. With the fall last night of 3.5%, the talk about default is rising again, even in the quiet month of August, setting up what people believe will be a very tough September if this trend continues.

I argue though that the move in the Nikkei is still just a correction within a rising bull market. Why? Well the trend model is still bullish as shown on the chart. Also, the US markets are still in a bullish uptrend though with the selling over the last few weeks, that bull trend is now having trouble - it is still a bull though. If the bull market remains, then that would imply that that the gap between the Dow Industrials and the Nikkei should close, as it did during the breakout in 2003. This would mean that the Nikkei is undervalued relative to the US market. The catalyst for this would be a reversal in the Yen which is in breakout mode as shown on the chart. A move back below the projected 115 level would imply a false breakout and could very well shoot the Nikkei past the Dow in terms of outperformance - this all implies that the Nikkei has the potential to rally 30% going forward.

So going forward, I believe the US markets hold their bullish posture which means the Nikkei is undervalued relative to the Dow, using the Yen as a comparison. If the Yen reverses course, and breaks back below the projected 115 level, we will have a false breakout - these normally imply a move to the bottom of the range or roughly the par level in the spot market. At a minimum, it would imply a 8% correction lower on the chart (higher in the spot market) to the 13 month MA. A break of that level would confirm the reversal.

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