- 1998: Volume 7, No. 1 International Corner: Japanese Stock Market: A Long-term View

Recent turmoil in Asia has pushed the Japanese equity market back to near the 14,000 level, an area which represents the lowest level for prices this decade and one from which the market has already twice rebounded from in the last few years. At the time of writing (late January), the market has undergone a sharp rally which has seen the index rise over 10 percent in as many days. But does this move merely represent short-term relief in a continuing bear market or does it herald the beginning of a more sustainable rise?

One way of gaining some insight into its likely future direction is to interpret price action in the context of the Elliott Wave. The theory, familiar to many, is that a sequence of five movements, or waves, defines the direction of the trend with countertrend moves occurring in sets of three moves.

The accompanying chart shows the Nikkei 225 Index over the last 10 years. The index peaked in late 1989, near the 39,000 level, and in less than three years lost over 60 percent of its value. Furthermore, this drop occurred in five moves, as can be seen by the labels on the chart, which defines the long-term trend as down. Price action, since then, has been essentially sideways, within the 14,000 to 22,000 range, which has served to correct this fall. The real question now is whether the weakness of the last few months represents the beginning of another leg down in the market or merely a further extension of the sideways trading of the last few years?

Figure 1

The preferred outlook is that the index completed a countertrend rally in the middle of 1996 and that the decline since then constitutes the beginning of a new bear market. The collapse in Japan's domestic economy and the severe crisis that has enveloped the region, over the last few months, is consistent with this outlook. To confirm this scenario, the Nikkei would need to consolidate below the 14,000 level which would break the line of support, just above here, and lead to much lower prices.

The most recent low in the Nikkei, in late December, was unconfirmed by weekly momentum readings but recent strength, towards the 17,000 level, has now pushed shorter-term measures towards overbought status and put slightly longer-term measures into neutral territory. The above level represents the first point of resistance for prices and above here a stronger barrier is marked in the 17,700 to 18,000 range. This zone represents both retracement resistance and the current position of the falling 30 and 50 week moving averages. If prices consolidate below here and subsequently fall back below the 14,500 level it would validate the preferred count and mean that the bear market had resumed.

An alternate, but less likely, longer-term interpretation for the index is that the sideways consolidation pattern of the last few years is still in progress. Under this scenario, the rally to June 1996 represents only the first part (or A wave) of the correction, with the drop since then labeled as wave B. This would mean that a final rally, or C wave, lies ahead which would take prices back to decade highs, above 23,000, before the bear market resumed. For the odds of this outlook to increase in stature, the index would need to consolidate above the 18,000 level. A rise above the 19,500 level would be needed to push this outlook to preferred status. 

Paul White of Trend Analysis Ltd is a technical analyst specializing in world equity markets. Based in the U.K., Trend Analysis publishes independent technical analysis on a wide range of financial markets. To contact Paul White, phone +44 (0) 181 441 9067 or e-mail vp31@dial.pipex.com.