Still Seeing Upside in Japan

Combining technical and economic analysis presents an interesting challenge, with not that many people on Wall Street actively using both disciplines. Anytime you find you're doing something not widely done on the Street, it can provide an edge.

What made me think of this was Helene Meisler's column today, entitled "Think About Taking Profits on Japan."

Helene has turned cautious on Japan. I have not.

It might be instructive to look at the iShares MSCI Japan Index (EWJ - commentary - Cramer's Take), as an example of overlaying a technical and economic approach.

A few years ago, I had recommended the Japan iShares; at the time, it was between $6 and $7. The reasons for that recommendation were twofold: First, Japan's economy was showing signs of life. Its GDP and consumer spending were improving, and rates had moved higher. It appeared that its long period of deflation was ending.

But that wasn't sufficient in and of itself. What I needed was additional confirmation prior to making a purchase.

At the time, the (second) key was the chart:

Turning Bullish iShares MSCI Japan Index (EWJ) 2000 - June 2003

At the same time, EWJ saw increasing volume as it tried to re-enter the previous trading range. The prior support was now resistance. Once it got over that level in the low $7s, the technical breakout confirmed the improving economics.

Helene bases her potential sell signal on a "black cross" -- where a rising five-day moving average crosses down through an also-rising 25-day moving average.

I revert back to the same analysis that got me into the position: As long as the new trading range holds, and the economic expectations for Japan remain expansionary, I plan on staying in the index; long-term investors can also stay long.

In sum, the same strategy that got me in, keeps me in:

Still in the Range, Still Bullish iShares MSCI Japan Index (EWJ) January 2003 - October 2005

It's also worth noting that the same approach has me increasingly worried about the U.S. equity markets next year.

The key in using technicals is to help with timing. Even though the economic backdrop is not at all encouraging, it is too early for me to short the U.S. domestic markets prior to a technical/quantitative/sentiment sell signal.

I do not see the markets as being "there"... yet.

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At the time of publication, Ritholtz was long the iShares MSCI Japan Index, although holdings can change at any time.

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.