GLOBAL MARKETS USUALLY FALL TOGETHER -- JAPAN TAKES THE BIGGEST HIT -- A FALLING YEN HAS ALSO HURT THE EWJ

NO DIVERSIFICATION ON THE DOWNSIDE ... Over the last few years, foreign markets have done a bit better than the U.S. market primarily because of the falling dollar. Having said that, however, global stock markets have been and remain highly correlated. The three lines in Chart 1 make that point. The purple line is the S&P 500 over the last year. The pink line is the Dow Jones World Index (DJW). The gold line is the Europe Australia and Far East (EAFE) Index. The point of the chart is that it's hard to tell the three lines apart. That's because they're very highly correlated. Global stock markets move up and down together. Some may do a little better than others at times. For example, foreign markets did better than the U.S. when the dollar was falling. Emerging markets did a little better than developed markets during the cyclical bull market. But when the global bull market peaks (and I think it has), expect them to fall together as well. This morning's headlines reported big losses in foreign markets over the weekend. That was in response to Friday's big losses in our market (when foreign markets were closed). That means that the idea of using global diversification to shield one from losses in the U.S. market is largely a myth. When the U.S. market falls, the others will fall as well -- even the Japanese market.

Chart 1

JAPAN FALLS THE HARDEST... Back in February, I wrote a bullish article on Japan that was based partially on the idea that Japan's low correlation to other global markets might make it more immune to a global slowdown February 14, 2005. The two lines in Chart 2 are the Europe Far East Australia (EAFE) Index (purple bars) and the Nikkei 225 Index (orange line) for the last year. The chart shows that they haven't been closely correlated. The Nikkei lagged way behind the global index from last August to December (see box) -- then did better than the other markets during the first quarter. That hasn't made the Nikkei immune to the recent selloff. In fact, its nearly 4% loss over the weekend was the world's biggest drop. The Nikkei also failed a test of a major resistance barrier.

Chart 2

NIKKEI FALLS BACK UNDER 11K -- EWJ WEAKENS... I showed the next two charts on February 14. The Nikkei 225 was testing major resistance at 12K which I thought it had a good chance of breaking through. It didn't and last evening closed back under 10K. That's not a major chart breakdown, but is a disappointment. A close below its 2004 lows near 10500 would be a more serious chart breakdown. Part of my Japanese optimism was also based on the bullish breakout by the Japanese iShares (EWJ) shown in Chart 4. However, it's inability to break through its early 2004 peak near 11 -- followed by the recent break of a yearlong support line (see circle) -- has weakened its short to intermediate trend. Major support is still visible near 9.0 if the EWJ drops that far. Part of the selling in the EWJ is also tied to recent weakness in the Japanese yen which fell to a six-month low against the dollar.

Chart 3

Chart 4

EWJ VS. THE YEN... I've explained before than Japan iShares (EWJ) are influenced by the direction of the Japanese stock market and the yen. Charts 5 and 6 show a correlation between the EWJ and the yen over the last year. Both are trading at new 2005 lows and have fallen under their 200-day moving averages. Both, however, are also in oversold territory -- especially the yen. I wrote this morning that the U.S. Dollar Index was starting to weaken from the top of its 2005 trading range and its 200-day average. If the dollar does start to weaken, any corresponding bounce in the yen could boost the EWJ. Having said that, however, I'm not as enthusiastic on Japan as I was a couple of months ago. One of the trading rules that I've written about is to start selling anything that closes under its 50-day moving average and especially if it falls under its 200-day line. Hopefully, those rules were followed by anyone holding a long position in the EWJ. If not, bounces in the EWJ should provide another selling opportunity.

Chart 5

Chart 6

WHY CHARTISTS ARE TALKING ABOUT 1140 ... Last Friday I expressed my view that the S&P 500 was headed toward its August low near 1060. A number of chart analysts, however, have been talking about the market being oversold and in chart support near 1140. Chart 7 shows what they're referring to. The daily RSI line is in oversold territory. There's also chart support along the June and October peaks near 1140. That's a logical spot to expect a short-term bounce. Expect initial overhead resistance at its 200-day average at 1154. Even if it gets through that, there's a lot of overhead resistance over 1160 which marked the January low. I'd use any S&P bounce to do some selling. Any bounce in the S&P should coincide with pullback in bear market funds. I'd use a pullback there to do some buying.

Chart 7