JAPAN LAGS BEHIND PACIFIC REGION -- GOLD MIGHT BE THE REASON -- FALLING COMMODITIES ARE HURTING CANADA AND EMERGING MARKETS -- HOMEBUILDNG STOCKS RALLY IN FACE OF BEARISH NEWS -- HOME DEPOT ENDS STRONG
PACIFIC EX-JAPAN ETF HITS NEW HIGH ... I wrote recently about strong uptrends in China and Hong Kong. I was asked by one reader why I hadn't included Japan. The reason is because Japan isn't doing nearly as well as the rest of Asia and the Pacific region. Chart 1 shows the iShares Pacific Ex-Japan Index Fund (EPP) trading well over its spring 2006 high. Exchange Traded Funds in that region that are trading at 52-week highs include Australia (EWA), China (FXI), Hong Kong (EWH), Malaysia (EWM), and Singapore (EWS). Not Japan. Chart 2 shows the Japan iShares (EWJ) well below their spring high. To be fair, the EWJ has underperformed the Nikkei 225 because of the falling yen. Since May, the EWJ has lost 10% while the Nikkie has lost 4.5%. During those six months, the Japanese yen fell 6% against the U.S. Dollar. But that still makes Japan one of the world's weakest markets. The question is why.
Chart 1
Chart 2
FALLING GOLD MAY BE THE REASON ... I've written in the past about the close correlation between the price of gold and the Japanese market. I believe the explanation for that correlation is Japan's attempt to move out the deflationary environment that plagued it for so many years. Rising gold prices signal a more inflationary global invironment which benefits Japan. Falling gold prices have the opposite effect. Whether you believe that or not, it's hard to escape how closely the two markets have trended over the last year. Take a look at Chart 3. The purple line is the Japanese iShares while the orange line is gold. The correlation isn't perfect, but it's pretty tight. Chart 4 shows a ten-year comparison between the two markets. Notice that the Japanese market bottomed in 2003 shortly after gold embarked on a new bull market. [Japan not only bottomed in 2003; it started to outperform the U.S. for the first time in a decade]. With gold down this year, Japan has become a global laggard once again. There may be a connection.
Chart 3
Chart 4
FALLING COMMODITIES HURT CANADA ... When commodity prices started to slide several months ago, I suggested that certain global stocks markets might suffer from falling raw material prices. One of them was Canada. Chart 5 shows the Toronto 300 Index (TSE) in the process of challenging its spring high. That's not too bad unless we consider that most other global markets have moved well beyond that chart barrier. The more important line on the chart is ratio of the TSE to the Dow Jones World Stock Index (solid line). Notice that the line has been falling since May. The means that the Canadian stock market has gone from a global leader to a global laggard during 2006. The line below the chart is the CRB Index which peaked in May. You can see a close correlation between the falling CRB Index and the falling relative strength line for Canada. Canada benefited from the bull market in commodities for several years. It's now being restrained by falling commodity prices.
Chart 5
EMERGING MARKETS ARE ALSO LAGGING ... I also suggested over the summer that emerging markets might suffer from falling commodity markets. I suspect there are other forces at work including a move away from riskier assets to more established large-cap stocks in developed stock markets. Even so, emerging markets as a group have become global laggards over the last six months. Chart 6 shows the Emerging Markets Ishares (EEM) still trading below their spring peak. The solid line is a ratio of the EEM to the Dow Jones World Stock Index, and it shows global underperformance by emerging markets since May. I suspect falling commodity prices have something to do with that since many emerging markets are producers of raw materials. Global leadership appears to have shifted to Europe and Asia (ex-Japan).
Chart 6
HOMEBUILDERS SHRUG OFF BAD HOUSING NEWS ... In the face of today's report that housing starts had fallen to the lowest level in six years, and permits the worst in nine years, housing stocks rallied. More correctly, they continued the rally that started earlier in the week. Two of the strongest stocks in the consumer discretionary sector (which had a strong week) were homebuilders. KB Home and DR Horton gained 11% on the week. Chart 7 shows KB Home breaking out to the highest level in five months on very strong volume. The homebuilding leader is nearing a test of its 200-day moving average. Many of the homebuilding stocks actually rallied today in the face of the weak housing numbers. A year ago I suggested that falling housing stocks warned of a housing slowdown. At this point, their ability to rally may be suggesting that things aren't as bad as today's housing numbers suggest. Keep in mind that the stocks lead the news -- not the other way around. The bounce in housing stocks also gave a big boost to Home Depot which closed the week on a strong note.
Chart 7
HOME DEPOT CLEARS 200-DAY LINE ... I suggested on Tuesday that there was a link between rebounding housing stocks and the rally in Home Depot, which is one of the nation's biggest home improvement stocks. The stock scored a very impressive upside reversal on Tuesday on massive volume. After consolidating those gains for a couple of days, the stock closed at the highest level in five months and finished the week on top of its 200-day average for the first time in six months. This week's strong housing and retail stocks made the consumer discretionary sector one of the week's strongest groups (second only to technology). It's a good sign for the market when both of groups are leading it higher.
Chart 8
