Abeconomics, Nikkei and Yen

by George Hatjoullis

dollar yen weekly

So what happened this week in the Japan equity market?

Placed in context one can safely say nothing very much happened this week. The Nikkei had almost doubled since last November. The rally was looking convex to the x-axis on a normal numeric (i.e. not logarithmic) chart. All measures of momentum were flashing overbought. Most still are overbought. The Nikkei was due a correction. It had been due a correction for some time. Given the technical parameters a correction was quite likely to be abrupt and severe. Why did it correct this week? For this I must refer you to previous blogs and the uric acid or gout analogy. [ I am not inclined to repeat myself and I am afraid all my blogs intertwine and form a continuous thread].

The technical parameters tell us that the uric acid level was high and some small perturbation could trigger a gout attack or in this case an abrupt and painful correction in the Nikkei. The perturbations were the poor China manufacturing data and the Bernanke hint that the US economy might be able to come off life support (QE) in the forseeable future. The same perturbations caused far less price action in other markets because the technical parameters were not so extreme. It happens.

So what now for the Nikkei? I am not sure what precise name the Japanese candle experts would give the weekly candle pattern (see above chart courtesy as always IG Index) but it almost certainly signals a top. Now this does not mean the Nikkei will now enter a bear market. Nor indeed does it mean the Nikkei will never move higher again. It simply means the previous trend has ceased. The most likely development is that the Nikkei will move sideways for a period in a range.

The same pattern was noted in the previous ‘Abeconomics’ blog in relation to dollar yen. Moreover as dollar yen has been leading the Nikkei this was a clue that some sort of pause in the Nikkei was imminent. Looking over history one can also see that the Nikkei was trading close to an important Fibonacci retracement level and had breached important resistance. More clues though none in themselves definitive. The likely pattern for the next several weeks is for the Nikkei to trade in a 14000 to 15300 range which matches the dollar yen 100 to 105.50 range.

The great risk to equities comes from the JGB market. If Abeconomics is successful then a repeat of the 1994 global bond market dislocation might ensue. This would involve market failure and it is unlikely any market would escape unscathed. If you are worried about your equity holdings then keep a wary eye on the JGB market. If yields start to rise quickly it may get ugly. The risk to JGBs and of market failure has been covered at length in previous blogs.