Japanese equities have seen quite the movements so far this year. The benchmark Nikkei index rose just about 50% from Jan. 2 until May 22, but it lost a quick 7%-plus May 23 following reports of Chinese manufacturing contraction and some troubling FOMC meeting notes.
It’s a frisky pup, this Nikkei. While the sharp and steady rise in Japanese stocks had already started by November 2012, the move accelerated to the upside in March and April as the Bank of Japan put the pedal to the metal on monetary policy easing. This “petting of the bulls” led to a significant weakening of the yen and the aforementioned vertical leap in Japanese equities.
The 7.3% drop in the Nikkei on May 23 thus far smells much more like a mean-reversion move rather than the start of something bigger. In my mind, this is just a decisive reminder that too steep a slope ultimately leads to aggressive pullbacks.
To be clear, this mean-reversion trade can easily move another 5%-10% lower, but given the construct of the multiyear chart below, it is currently less likely to lead to a complete reversal of trend.
The chart here of the iShares MSCI Japan Index Fund (EWJ) looks back to 2007 and points out three distinct trends over the past six years:
- A sharp selloff into the 2008 lows.
- A multiyear sideways shuffle from 2010 through most of 2012 (albeit all at levels well above the 2009 washout lows).
- A sharp rally so far in 2013.
On a closer-up daily chart of the EWJ, note that Thursday’s slide took it very close down to the November 2012 uptrend (blue line), which should act as some support.
Any daily close below there — e.g., below the $11 area — could attract the EWJ to lateral support near $10.50-$10.60, which also would reflect a 50% retracement of the entire November-May snapper rally and likely offer better long-side entry levels again for bulls.