Indicators Point to Another Down Leg in This 23-Year Bear Market

Every once in a while, traders seem to forget that market prices move up and down and start expecting to see a move in one direction last forever. In the late 1980s, many traders assumed that the Japanese stock market was on a one-way trip up, and some believed there was no way to stop Japan's economy from growing. They were wrong, and a 23-year bear market has now led to the opposite feeling -- that Japan is in a never-ending decline.

Japanese stocks actually make fairly large moves up and down. The index is about 26% above its October 2008 lows, but has made six moves of 19% or more during that time. On average, the index delivers a tradable trend about every eight months.


Indicators, including recent news, show that the next trend in Japanese stocks is likely to be down and could be starting now. At the beginning of October, the Bank of Japan lowered its expectations for the economy and noted, "Japan's economic activity is leveling off more or less." This statement reinforced the opinion that the central bankers offered a month earlier that growth "has come to a pause."

Business leaders in Japan appear to agree with the central bank's assessment. International companies will invest where they can get the highest return on their investment and Japanese companies are increasingly turning overseas. According to Bloomberg, Japanese companies spent a record $88 billion on overseas acquisitions last year, and after Softbank's (OTC: SFTBY) recent $20 billion acquisition of Sprint Nextel (NYSE: S), analysts believe a new record might be set this year.

Softbank is a former Internet bubble stock that has survived and prospered in the downturn. Softbank is now Japan's third-largest wireless phone company and owns a number of websites. It is an Internet giant in Japan, and its stock has been among the leaders since the October 2008 bottom, gaining more than 420%.

From these news stories, we know that the Bank of Japan sees the economy slowing, and SFTBY and other Japanese companies with capital to invest are looking outside Japan. These are signals to traders that the Nikkei could be vulnerable to another decline and the charts show that a short trade could be profitable.

Rather than shorting Nikkei futures, traders can buy ProShares UltraShort MSCI Japan (NYSE: EWV) to profit from a drop in the Japanese stock market. The weekly chart of this ETF shows that the stochastics indicator just gave a buy signal.

We can also see in the chart that Bollinger Bands are contracting, an indication that volatility could pick up shortly. The Bands move closer to each other for a time and then expand away from each other. Narrow distances between the Bands show a consolidation, and a breakout usually follows. In the past when the Bands have contracted on EWV, the price has broken out in the direction indicated by the stochastics, which is up.

Another bullish indicator is the fact that the price is above the midpoint of the Bollinger Bands. After EWV moves above the 20-week moving average, it has hit the upper Band in the past. The monthly chart shows the same technical setup and an initial price target of $39.61. After clearing resistance at that level, EWV could reach $45.75, a target based on the triangle pattern that can be seen in the weekly chart.

Japan's stock market is once again a sell on the charts. And the fundamentals, i.e., indications from the country's monetary authorities and largest companies, support the sell recommendation. EWV is an ETF that allows individual investors to sell Japan easily.

Recommended Trade Setup:
-- Buy EWV at $36.60 or less
-- Set stop-loss at $33.30, the lower limit of the triangle pattern
-- Set initial price target at $39.61 and long-term price target at $45.75, for potential gains of 15% to 33% in 4-6 months