Japanese Stocks are Burning, We Smell Profits

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For more than two decades, investors have avoided Japanese stocks. The Nikkei (^N225).has been stuck in a long-term downtrend and like O.J. Simpson and Pete Rose, nobody in professional sports wanted anything to do with them.

But something changed.

Japanese stocks began an impressive rally. From October to April, Japanese stocks surged 40%. And that surge, by the way, was just enough to get the financial experts away from the Ferraris and yachts and back in front of the cameras.   

Before we go any further into the explicit details of Japan's latest stock market rout, here's what the experts have been saying:

"Japanese stocks remain in a bull market, premium justified: JPMorgan" - Financial Post, May 2, 2013

"Asset Manager DIAM Sees Long Bull Market for Japan Stocks" - Wall Street Journal, April 16, 2013

"Neil Hennessy: 'Japan is entering a true bull market'" - MarketWatch, April 17, 2013

"Why Dan Loeb Loves Japan" - Fortune, May 9, 2013

Another expert, whose identity we're protecting, went as far to say, "The Tokyo market (NKY - News) could triple from here and it would still be lower than it was in 1989!"

Never mind the fluffy forecasts, the accompanying chart (see below) shows you the real action. As illustrated, the iShares MSCI Japan ETF (EWJ - News) has nuclear bombed half of its yearly gains within a matter of just 10 trading sessions. 

The Conventional Wisdom is Wrong Again! Here's what the value camp has been saying about Japanese stocks:

"If the Nikkei 225 doubled it would still be cheaper than the S&P 500 on a price-to-book value basis."

Remember: The most important single factor shaping security markets is public psychology*, NOT market valuations. And that's why investing or trading by strict valuation measures while ignoring price trends and market sentiment is akin to skydiving without a parachute. It's never a soft landing.

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What about the central banker argument? Here's what they've been saying:

"Don't fight Japan's central bank. The Bank of Japan is in a super-accommodative mode and asset prices heading higher and higher into the stratosphere is a slam dunk."

Did you know that two of the last 50% stock market declines (2000-02 and 2008-09) happened during periods of aggressive and relentless easing by the Federal Reserve?

Portfolio manager and stock market historian, John P. Hussman, Ph.D., correctly observes that "favorable monetary conditions were associated with far deeper drawdowns." ("Drawdown" is a peak-to-trough decline in the price of an investment over a specified period. Calmar and Sterling ratios use this metric to compare a security's possible reward to its level of risk.) 

Here's the translation: Aggressive monetary policy has done an excellent job of fueling asset bubbles, but a not so excellent job at preventing massive corrections. And Japan's "Abenomics," just like U.S. styled "QE" is still a giant and unproven experiment.

A Better Approach to Profits It's always better for investors to focus on price trends rather than double talking analysts and central bankers. He who ignores prices does so to his own peril. Via our June 2013 Profit Strategy Newsletter we wrote:

"Kabuki = Japanese Theatre and the 7.3% crash in Japanese stocks on May 22 provided equity investors with much unwelcome drama. Cleary, the stock market's fickle mood can turn quickly, no matter how much money central banks are tossing around."

We followed that up with our ETF Weekly Pick which on 5/29 wrote:

"The roughly 10% one-week loss has taken the iShares MSCI Japan ETF (EWJ) just below its 50-day moving average. If we get more follow through selling, it could push EWJ toward its 200-day level, and therein lays the opportunity. Buy the ProShares UltraShort Japan ETF (EWV - News) at $21.17."

Since then, EWV has spiked around 9% and we were able to turn a quick profit. EWV aims for double inverse or opposite daily exposure to Japanese stocks. Our EWJ put options trade, given in that same alert have surged +70%. (position still open)  

The ETF Profit Strategy Newsletter uses common sense along with fundamental, technical, and sentiment analysis to dissect what is really going on in the markets.  We offer a monthly newsletter, weekly ETF picks, and a twice weekly Technical Forecast that follows the equity, bond, commodity, and forex markets.

P.S. Through the June 4 market close, 78% of our Weekly ETF Picks have turned a profit and our biggest winner was a +525% gain. (YTD results) #timestamps 

*Gerald Loeb

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