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May 17, 2006
As Stocks Correct, Watch The Double Ns
By Brady Willett

Before last nights rebound the Nikkei had logged a six day losing streak for a total loss of -1,133 points (or -6.5%). For a market that had gone straight up since October that the Nikkei was a mere 2% loss away from correcting 10% from April’s highs is noteworthy. To be sure, although a 10% decline during a bull market is usually deemed a correction, anything greater than a 10% decline threatens to become a bear.

The recent carnage on the Nikkei has hardly been isolated. Rather, the US stocks dropped sharply last week, emerging markets (and any market overweight commodities) got hammered on Monday, and European stocks - as measured by the FTSE 100 - are off by 7% in just over a week. To top off this negative action, US stocks suffered major declines again today, with the Dow shedding more than 200 points for the first time since January and the Nasdaq turning negative on the year.

While this weakness could certainly snow ball into a larger correction, it is nonetheless important to remember that global stocks are sliding from a position of widespread strength.  To be sure, despite sharp declines around the globe, leading into today only one major index, the Nasdaq, was trading below its 200 DMA. In other words, it is going to take a much deeper sell off before the 2003-current bull (or cyclical bear market rally) is in serious jeopardy (during a bull corrections often find support around the 200 DMA, and when stocks are in a bear market rallies usually encounter resistance at this mark. The 200 DMA is, for lack of a better way of putting it, the poor technicians guide to longer-term bull and bear trends).


On April 14, 2000 – a date that I have mentioned on many occasions in the past – the major US stock markets plunged as traders were short selling stocks on the expectation of margin calls being made later in the day.  The Dow crashed by more than 600 points and the Nasdaq by more than 300.  Beyond these share price plunges April 14, 2000 was significant for one reason: Every major US market broke through their 200 DMAs. Is another April around the corner?


As a side note, although I don’t believe any investor should buy and sell stocks based solely on technical analysis, I do think that it is important to try and understand what moves the markets in an attempt to get the best price when buying undervalued companies. In short, everyone pays attention to 200 DMAs, and this is why it is worth paying attention to. 

Back To The Nikkei
 
Although simplified somewhat, one of primary ingredients of ‘global rebalancing’ is a Yen strengthening against the dollar, Japan raising interest rates from around zero for the first time since 2000, and the Japanese consumer buying more American exports.  While this tale made perfect sense when Japan was recovering strongly (perhaps this recovery hinges on a weak Yen?), and when capital from around the world was pouring into Japan, there is reason to believe that the conditions for recovery are flashing yellow.  Quite frankly, Japanese officials are already jawboning a strong Yen, Japanese consumers have not (yet) seen any notable increase in wages to help fuel spending, and now stocks are moving lower.

If the Nikkei crashes by more than 10% in a month Japanese officials – the most blatant plunge protection artists in the world – would start getting nervous. Global investors, already nervous and rethinking their emerging market gambles, could find reason to flee Japan…

Yes, the markets are hardly at a panic stage, ‘yet’. The Nikkei is still above 16,000.  This is an impressive number given that Dow Jones Industrial Average and Nikkei ended 2002 less than 250 points apart. 

In short, watch the beaten down Nasdaq for signs of investor life, and watch the Nikkei/Japan for clues about when the hope for a painless global rebalancing will die.