An ETF for the Rising Sun

03/25/2005 12:00 am EST

Focus:

John Murphy

Head Market Analyst, Stockcharts.com

Japan may be out-of-favor in many investors’ minds. But to technical wizard John Murphy, it is "the land of the rising sun, the rising yen, and maybe even a rising stock market." Here’s his overview and way to play this trend via an exchange traded fund.

"Strength in the Japanese yen over the last year has attracted foreign buying into the Japanese stock market. Even so, it's been one of the world's weakest stock markets. The good news is that may be changing. And that may make Japan one of the world's best stock market values. Indeed, the Japanese stock market may be near a bullish breakout. Since 1990, the Japanese market has been the weakest in the world. It was also the weakest last year. But things may be finally looking up.

"The Nikkei 225 Index bottomed at the start of 2003. Since then, the Nikkei has been trading sideways in what technicians call a ‘triangular’ shaped pattern. That's bullish for two reasons. First, a 'triangle' is normally a continuation pattern. That means that the next move should be to the upside. Second, from a technical perspective, the next uptrend would probably break the horizontal ‘neckline,’ which would represent a major bullish breakout for the Japanese market.

"One of the side effects of a weaker dollar is that it pushes money into overseas market. Japan has been one of the beneficiaries of that trend since 2002. One of the best ways to benefit from both of those trends (a rising Japanese yen and a rising Nikkei) is with iShares Japan (EWJ ASE), which is a Japanese exchange traded fund. The EWJ has already exceeded its early 2002 peak, which is now acting as a support level. Following the January report of stronger-than-expected Japanese industrial production and retail sales, the Japan iShares has technically completed a bullish triangle and is moving close to a new four-year high.

"I’d also note that the rising yen (or a falling dollar) has given a much bigger boost to the iShares than the Nikkei 225 Index. The EWJ has already exceeded its 2002 peak, but the Nikkei 225 has yet to clear that major chart barrier. The Nikkei is at a new seven-month high and appears to be on the verge of a major bullish breakout of its own. The reason why the EWJ is stronger than the Nikkei is that the EWJ is priced in dollars while the Nikkei is priced in yen. That's why a rising yen helps the EWJ more than the Nikkei and why the EWJ is probably a better way for investors to play the Japanese stock market.

"Meanwhile, Japan provides investors with real global diversification. Although it's true that foreign markets have done better than the US over the last few years (owing mainly to the falling dollar), it's also true that global markets have been very closely correlated. In other words, they've been moving up in lockstep with each other. Indeed, the Europe, Australia, and the Far East indexes don't look much different than the US market. That diminishes the basic value of diversification, which is to put one's funds into markets with little or no correlation. That's where Japan comes in.

"The land of the rising sun has the lowest correlation with other global markets. That may not mean much if the global bull market continues. If the global bull stumbles, however, most of the world's highly correlated markets will fall together. Since Japan has been a global laggard, and shows poor correlation to other markets, it's an excellent candidate for global diversification. And when global money managers decide that some of the world's strongest markets are getting overvalued, they're going to start looking for some place that's undervalued to do some global rotation. My guess is that Japan will be at or near the top of their list of places to put some money."

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