Does Breadth Support A Breakout For Japan?

Steve Strazza
October 6, 2020

From the desk of Steve Strazza @Sstrazza

Last week’s Mystery Chart featured an ominous rounding top, complete with price violating key lows as it aggressively collapsed. 

Today, we’re going to turn that frown upside down. It actually wasn’t a rounding top at all.

We inverted the chart, as we often do, in an effort to make some of you out there aware of any bullish or bearish biases you may have. 

In other words, if you were buying this chart (which most of you were NOT), you are really a seller. And if you’re a “seller” who only bought the Mystery Chart because you have a bullish bias, you might now be wondering why you would ever bet against such a nice base. 

When we flip this chart around, you can now see we’re looking at a massive base on Japan’s Nikkei 225.

In this post, we’ll check in on the Nikkei and see what market breadth is signaling about the internal strength of the Japanese stock market.

The Mystery Chart wasn't just the Nikkei 225 as it's normally quoted, in its local currency. I guess we made this one extra hard. It was the Nikkei priced in US Dollars.

Why did we do this?

The main reason is that if you're a US investor, this is a better representation of the performance you're actually going to get after the currency conversion impact.

The more important takeaway is that we're at fresh highs. These aren't just any new highs... price just broke out of a multi-year base within a multi-decade base to its highest level since 1990.

I don’t think I have to tell you it would be a huge development if the Nikkei could finally make a sustained breakout from this 30-year bottoming pattern. 

Japan is the 3rd largest economy in the world. It’s hard to imagine a situation where global equities are under pressure in an environment where Japanese stocks are hitting their highest level in three decades.

Here's how we're currently viewing the Nikkei in Yen from a long-term perspective.

Unlike in USD, this chart is trapped slightly below its recent highs.

We wrote about the Nikkei in a recent RPP Report and noted that we can expect it to retest its multi-year highs near 24,400 if it holds above the June pivot highs near 23,200. That's our tactical outlook.

Over the longer-term, 24,00-24,500 is the zone we want to watch. If/when we finally get that breakout, we'll want to be aggressively long and buying this index and Japanese stocks hand over fist.

Although, in the Mystery Chart post, we zoomed in a bit and showed a multi-month bearish momentum divergence. We're seeing the same thing on a local currency basis. And that's not the only divergence.

Here is a look at the percentage of new highs from Japanese stocks across multiple timeframes.

First of all, new highs are diverging as the index makes incremental highs. This isn't always a big deal. But in the case of Japan, unlike the US and some of the strongest countries in the world, they did not experience a similar bullish breadth thrust in Q2 of this year. You can read more about these breadth thrusts here.

Further, most new high readings are actually much lower than where they were over the past several years when the index was testing similar levels as it is today. This is evidence of deteriorating internals over multiple timeframes. The fact that the Nikkei couldn't pierce through this key 24,000 level when it was supported by much stronger internals back in 2017-2018 doesn't make us feel too confident about the potential coming retest.

This weakness in breadth isn't just showing up in the percentage of new highs, but also for the percentage of overbought stocks. We're seeing a similar divergence today as we did in Q1.

Also unlike US markets, the peak reading from Q2 was well below its highs from last year.

What we really want to know is if the Nikkei finally has enough juice to resolve higher from this massive base. I can't reiterate enough how bullish this would be for world equity markets.

But for now, all we can do is wait for more data to come in.

Is breadth just too weak, and we should prepare for yet another failure?

Or, will the Nikkei soon rip through those former highs just like it did on a US Dollar basis?

Based on what we're seeing from the market internals, we're leaning towards the former.

Do you think we have this right? Let us know.

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Allstarcharts Team

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