Never mind recession, Japan may lead U.S. stocks higher

Wall Street has been celebrating a string of record highs for U.S. stocks, but savvy investors had better keep close tabs on another index: Japan’s Nikkei.

While the Nikkei tumbled 3% Monday in the wake of the Japanese economy’s unexpected fall back into recession in the third quarter, the index still enjoys positive technical momentum that has bulls looking for a long-awaited test of its 2007 high.

Technical analyst and widely-followed market blogger Chris Kimble of Kimble Charting Solutions argues that, Monday’s stumble aside, the Nikkei’s newfound outperformance of the S&P 500 could provide a bullish signal not only for Japanese stocks but for other major indexes as well.

Here’s how it works: Kimble’s chart above tracks the Nikkei/S&P 500 ratio. When the ratio is going down, the Nikkei is underperforming the S&P. When the ratio is rising, the Nikkei is outpacing the U.S. benchmark.

Not surprisingly, the Nikkei has been a laggard since the early 1990s as Japan wrestled with deflation and a stagnant economy. The Nikkei has been underperforming ever since Japanese companies “bought Rockefeller Center and Pebble Beach,” Kimble told MarketWatch in an interview.

Japanese stocks rallied sharply in the wake of the Bank of Japan’s surprise Oct. 31 decision to expand its quantitative easing program. After Monday’s setback, the Nikkei 225

NIK, +2.18%

 is up 3.4% for the month to date and has rallied 4.2% since the beginning of the year. The S&P 500

SPX, +0.07%

 is up around 1% so far in November, having rallied more than 10% in the year to date.

Kimble also notes that unlike most other major stock indexes, the Nikkei has yet to push back above its pre-crisis 2007 high.

While it’s too early to say for sure, there may be a change afoot.

As the chart highlights, the Nikkei/S&P 500 ratio is still attempting to break above nine-year trend-line resistance. Meanwhile, the Nikkei remains around 7% below its 2007 high.


From a technical perspective, the Monday setback by the Nikkei hasn’t undercut the picture, Kimble says. The Nikkei is near the top end of a long-term trading range while still enjoying strong momentum, he says.

From a fundamental standpoint, the GDP shocker reinforces the divergence between monetary policy in Japan, which is set to remain extremely loose, and the U.S., where the Fed is seen on track to begin raising interest rates next year, wrote economists at Capital Economics. The firm expects the Japanese yen to remain under heavy pressure, leading the way for the Nikkei to end this year near 20,000.

Back on the charts, a move by the Nikkei/S&P ratio above trend-line resistance and the Nikkei through the 2007 high would likely spark money managers to put on pair trades, buying the Nikkei while shorting the S&P 500, Kimble says. At the same time, other investors would likely be eager to just buy Japan securities outright.

But an outperforming Japan wouldn’t necessarily leave U.S. stocks in the muck, either. That’s because the Nikkei, when it’s on a roll, has a tendency to serve as a global leader. It would be a surprise, Kimble says, if Japan’s market did well and the rest of the world foundered.

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Never mind recession, Japan may lead U.S. stocks higher
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