The drop in US stocks since the start of 2014 is nothing compared to what's going on in Japan. The Japanese benchmark Nikkei 225 index is off by 11% while the S&P 500 index is "only" down by 4%.
It seems that where Japan goes, the United States follows, and vice versa. John Kosar, President of Asbury Research, says American investors should watch crucial levels in the Nikkei if they want an idea of what's next in the US.
In recent months, the two indices have been moving together, thanks in part to simultaneous monetary stimulus by the Bank of Japan and the Federal Reserve Bank. Though the size of the BoJ's monetary stimulus was roughly the same size as that of the Fed's, it had treble the impact since Japan's economy is one-third the size of America's. No surprise, then, that while the S&P 500 was up 29% in 2013, the Nikkei soared nearly 57% even after a taking a severe hit in May.
But, which market leads which?
"It looks like it kind of switches off," says Kosar. "I don't see any pure pattern here where one is leading the other. It's whoever is in the news and what's going on economically on that particular day. I think lately, it's probably been Japan."
(Read: Japan stocks lead gains in Asia ahead of US payrolls report)
Kosar sees Japanese stocks as moving in a long-term secular downtrend that began in June 1996. Two earlier peaks corresponded to peaks in the US markets – April 2000 and July 2007. At the end of 2013 and the start of 2014, the Nikkei broke above its downtrend line for the first time in 18 years only to quickly drop below it.
"That sets up what I would call a secular inflection point from which the next big trend out of here is going to happen," says Kosar.
On the nearer-term, Kosar says there a few key points to watch in the Nikkei.
From January to until May 21, 2013, the Nikkei made a determined move up to the trend line from 1996. Around the time the trend line was reached, then-Fed Chairman Ben Bernanke announced the Fed would begin tapering its monetary stimulus. That sent world stock markets into a bit of a panic, leading to a massive selloff in stocks that lasted for about one month.
According to Kosar, the Nikkei then traded in a symmetrical triangle pattern pointing to 13,540, one of Kosar's key levels. In September, the Nikkei resumed its uptrend towards the old 1996 trend line, which is currently at 15,590.
"As long as we stay up above 13,540," says Kosar, "that points to 17,250 – 22% higher than where we are right now."
Staying above 13,540 means the Nikkei is in good shape, believes Kosar. "And, because it's positively correlated to the S&P, it's also good for our market," he says.
Likewise, if the Nikkei falls below that level, things may start to look gloomy in the Japan and, subsequently, in the US. "If we start trading below 13,540," says Kosar, "that pattern fails and it points to significantly lower Nikkei over the next one or two or three months."
As well, a third key level for Kosar is the 200-day moving average for the Nikkei. While holding above the 13,540 may be a bullish sign, staying above the 200-day moving average at 14,432 would confirm it.
"I want to see us get back up to the 200-day moving average at 14,432," says Kosar. "So, we have to hold 13,540, rise back up above 14,432, and I think at least for the near term, things are okay. The Nikkei can go higher and so can we."
The Nikkei closed Friday at 14,462.
To see Kosar fully discuss his two charts on the Nikkei, watch the video above.
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