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Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Eerie Nikkei-SPX Parallels

Since Japan is about a decade ahead of the United States in its own post-bubble journey, the countless parallels between the Japanese bust experience of the 1990s and the American bust experience of today are fascinating.

Market history never repeats itself exactly, but it does tend to rhyme rather well. Timeless market forces like valuation, greed, and fear that drove the legendary great booms, bubbles, bursts, and busts of the past are just as potent and influential on todays markets as they always have been. While the decades and markets change, the emotional human heart shared by all investors and speculators does not.

The Japan-US comparisons are so interesting because they offer some tantalizing insights into the general timing of the emotional waves of greed-driven rallies and fear-driven selloffs that inevitably follow a Great Bubble. There is really no reason why the timing of bear-market rallies and selloffs in the United States in the early 2000s should match that of Japan in the early 1990s, but remarkably the timing generally does match!

Why do these inter-decade trans-Pacific market parallels exist? I certainly don't know for sure, but I suspect it delves deep into the realm of common human psychology. Speculators, the driving force behind all short-term market movements, are all very similar across the globe.

Japanese speculators facing the bursting of the Nikkei 225 in late 1989 experienced the exact same chilling fear as American speculators did when the NASDAQ burst in early 2000. Greed and fear are universal and timeless human emotions, transcending all eras, cultures, and peoples. Regardless of when or where a speculator grew up and trades, he faces the same struggles and triumphs, the same despair and exhilaration, as all other speculators in history.

Speculation, and the eminently predictable emotions that it always breeds, is a common human experience among those who choose this challenging path in life. And if greed and fear are the same across all eras and cultures, perhaps general popular tolerances for these emotions are similar as well.

Maybe popular greed after a Great Bubble bursts can only survive for around 8 months at a time on average, or a year, or some other quasi-universal length of time before the collective herd of speculators grows uneasy and the emotional pendulum starts relentlessly swinging back the other way. While it is hard to define why this would be the case, the charts comparing the Japanese bust experience of last decade and the American bust experience of today certainly seem to exhibit just this odd phenomenon!

Back in August I wrote an essay called "Japan and US Busts" that delved into these eerie Nikkei-SPX parallels from a grand strategic perspective. In that essay we offered sweeping charts spanning almost two decades, definitely a macro view of the famous Japan-US parallels. This week I would like to continue these studies but zoom way in to a short-term tactical perspective that is really quite amazing.

In order to set the stage, our first chart this week is an update of the final graph presented in "Japan and US Busts" a few months ago. It will help ensure that the current short-term tactical Japan-US market comparisons are understood within the important strategic context since their respective bubble tops.

As I discussed in my earlier essay, we had to index this disparate data to make it comparable. A level of 100 represents the bubble tops of the Nikkei 225 in Japan, and the mighty S&P 500 and speculative-mania-central NASDAQ in the States. This common indexed scale ensures that these very different indices are absolutely comparable in their crucial raw percentage terms. For example, a fall from an indexed 100 to an indexed 90 in any of these flagship indices represents a true real-world 10% drop that the respective underlying stock index actually witnessed.

The horizontal time axis is also indexed, as these bubble events transpired in different decades. This time-component indexing centers around week 0, which represents the respective mania bubble tops in each market. Negative weeks count down towards the Great Bubble tops and positive weeks count up after the tops passed. With both a common vertical percentage scale and horizontal time scale, precise comparisons may be made between the Japanese and American bust experiences.

From a grand strategic perspective, it is really interesting that the post-bubble experiences in both Japan and the States followed a remarkably similar pattern. A decade of time, a vast cultural gap, and the world's biggest ocean separate these two unique national bubble busts, but for unknown probably speculator-psychology and herd-behavior reasons they have essentially followed the same script in their initial bust years.

In both Japan and the States, there were really only four major bear-market rallies (less than one year in duration) or cyclical bull markets (greater than one year in duration) in the first four years after their respective bubbles burst. All four rallies are labeled above and even from this strategic perspective it is rather remarkable how closely the timing in the US in recent years has tracked Japan's precedent of the early 1990s.

The first major rally was the typical post-crash bounce, probably the most distinguishing feature of any Great Bubble burst. Even in charts of the infamous 1929 US crash, this first post-burst rally is quite prominent and eye-catching. This first rally was well-defined in both the Nikkei and NASDAQ in percentage terms as shown above, but it was much more subtle in the S&P 500.

As you no doubt remember, many investors wrongly thought that the S&P 500 was insulated from the tech disaster during the summer of 2000. While the S&P 500 fought valiantly until late August 2000, five months after the NASDAQ crash, it too ultimately succumbed to the overwhelming Great Bear pressure of the receding Long Valuation Wave. After the failure of rally 1 in each index, the selling began in earnest.

Rally 2 in both Japan and the US erupted after the brutal downleg following the failure of rally 1. This second major rally was short-lived as well though, just a garden-variety bear-market rally, and it soon failed and rolled over. Rally 3, which lasted a little longer, erupted out of the ashes of rally 2 before it too finally became exhausted and another long grinding Great Bear downleg commenced.

On the chart above it is amazing that the relative timing of rally 2 after the bubble tops was almost identical in the US to what it had been in Japan a decade earlier. Why did these major rallies, in different countries in different markets in different decades, launch skyward almost to the very same relative week? Your guess is as good as mine, but it is certainly an eerie Nikkei-SPX parallel worthy of note!

The third major rally is not quite as comparable as the second one between the States and Japan. There was indeed a powerful rally in Japan around that time, that topped near the same relative week that rally 3 did in the US, but the Japanese rally 3 started a bit later than our American ones. While there is no reason that the US bust should be held rigidly to the Japanese bust's timetable, I suspect that the 9/11 attacks may offer a partial explanation for this relatively modest timing difference.

The V-bounce leading into rally 3 was the fateful one that happened a couple of weeks after the 9/11 attacks in the US. At the time the US Fed was utterly terrified and was pumping staggering amounts of liquidity into the system to stave off a financial meltdown, so it is not too unreasonable to assume that perhaps the start of rally 3 in the US would have been some weeks later if the 9/11 episode hadn't catalyzed it a bit earlier than Japan's rally 3.

After the third major rally, which incidentally topped right around the same amount of time after the bubble tops in both Japan and the US, a long grinding downleg commenced in both countries' respective busts. This is the exceedingly ugly downleg that ended in October 2002 in the States, at a dismal S&P 500 level of 777, almost 50% lower than its bubble top. This major bounce preceding rally 4 happened at week 135 for the Nikkei, week 131 for the S&P 500, and week 133 for the NASDAQ, definitely an eerie parallel!

Then major rally 4 launched. This rally, really a cyclical bull market within a Great Bear since it lasted more than one year in both countries, is the one we are currently experiencing in the United States today. Just as in the US, last decade in Japan it was a totally different type of rally than those that came before it in the Great Bear. It was longer, slower, more powerful, and much more convincing than the first three major rallies. It is this fourth major rally that is of immense interest to American investors and speculators today.

In order to investigate our current bust trajectory in the US relative to Japan more closely, this week we zoomed in to rally 4, the yellow-shaded area in the chart above. Since we needed a higher resolution to compare the current eerie Nikkei-SPX parallels, we ran our next chart denominated in trading days rather than weeks. Day 0 below is the very day that rally 4 erupted in each index in each country, enabling the various major rally 4s to be precisely compared.

In actual date terms, the graph below covers the daily Nikkei 225 from June 1992 to December 1993. The American S&P 500 and NASDAQ run from August 2002 to the present, which is rather uncannily almost exactly one decade to the very month after the Japanese bust experience! The more one delves into these Nikkei-SPX parallels, the stranger they become!

We also had to re-index the stock indices, but to a different scale. Since we are looking at a major rally alone in this case, it made much more sense to apply 100 to the various bottoms below to compare gains, rather than to the tops as above to compare losses. This base 100 level at the bottoms allows us to compare the rally 4s in perfectly congruous percentage terms. A move from an index 100 to an index 130 in either the Nikkei, S&P 500, or NASDAQ, for example, represents an absolute 30% gain in all the underlying indices.

Now I am a hyper-jaded chart guy who has built and analyzed many thousands of price charts over the years, so graphs usually don't surprise me very much. This one, however, is just plain weird and wild, both awesome and perplexing and maybe even disturbing at the same time. Why on Earth would the US track the Japanese bust experience so well at an actual day-to-day tactical level a decade later? I have no idea. This ought to be fiction, but it is reality. The markets never cease to astound their diligent students!

Now this certainly is an eerie Nikkei-SPX parallel friends! Not only separated by a long decade of time in which the world changed dramatically, not only separated by a vast cultural gap between two incredibly different nations, not only separated by a seemingly endless ocean, but amazingly the US major post-bubble-rally-4 experience thus far is almost exactly tracking that of Japan! Weird. Weird I tell you!

This fourth major rally of the American Great Bear started just like that of Japan, with a blistering and wickedly fast bear-market rally off a V-bounce. In Japan this rally 4 opener blasted up over 30% before fading, comparable to what the NASDAQ did, albeit slower in the States, but half again as far as the S&P 500 managed in its own initial surge. Nevertheless, the timing of the rally 4 birth is very similar and the magnitudes of the Japan-US bear rallies are definitely comparable.

After this typical bear-marketish start (believe it or not, the biggest baddest meanest rallies in market history are almost all found in bear markets), rally 4 in both Japan and the US began to grind relentlessly lower. This sideways decay ran until almost exactly 105 trading days after the birth of rally 4 in both countries before a powerful new uptrend commenced. And now things start waxing really strange again.

In the US, this sharp rally that erupted 105 trading days into rally 4 is known as the war rally. It soared in mid-March as the uncertainty over Washington's controversial annexation of Iraq faded. The markets were very relieved and exploded into a war rally a week or so before the actual bombs started flying just because investors and speculators finally knew that the whole vexing issue of Washington's Iraq war would finally come to a head. We are still in the late stages of this very war rally in the United States today.

Now I really doubt that any American market player would dispute the argument that the war rally was sparked by geopolitical events. Herd psychology is the single most powerful force driving short-term market movements, and the relief evident when Washington's invasion of the Middle East was finally set in stone was palpable. To the financial markets, uncertainty about a potential war is much more difficult to handicap and live with than an actual war itself!

If you closely examine the chart above, it boggles the mind that in Japan around this same day 105 into rally 4 the Nikkei 225 surged and began a powerful multi-month rally of similar magnitude to both the S&P 500 and the NASDAQ a decade later! This was about January 25th, 1993 in Japan. I personally cannot remember way back to January 1993 for the reason given at the time for the Nikkei's rally, but I really doubt it was geopolitical in nature.

These amazing parallels, almost to the very day, are uncanny! They are both exciting and disturbing as they suggest, give us a tantalizing hint at least, that herd-psychology forces underneath the surface driving the post-bust market behavior are more potent and perhaps even predictable than most people can even fathom. Were the US markets "destined" to rally around 105 days into rally 4 for speculator-psychology timing reasons that cannot be quantified? Would the war rally have happened anyway, even without the war? Even though we will never know these answers, these questions provide much food for thought!

Following this eerie day 105 event, both the Japanese and US markets soared in a relentless secondary rally that officially created mirror-image cyclical bull markets, since it extended the entire rally 4 to last one year or longer with a 20%+ actual index gain. If you carefully examine the yellow Nikkei 225 line above compared to the blue SPX or red NASDAQ line, it is really startling how closely some of the minor peaks and troughs coincided across the two Great Bear busts. These trans-Pacific lines often look like keys cut for the same lock!

For example, around days 180 to 200 in both the Japanese and American experiences in rally 4, initial interim tops were achieved. Both countries' markets traded sideways to lower for a month or two after these midway interim tops, but then once again started marching higher. The Japanese markets managed to challenge these midway interim tops a little later around day 260, but they couldn't surge to a major new upside breakout. Rally 4 was failing.

In the States a decade later the S&P 500 did manage to grind modestly higher towards day 260, but its trading action since its first apparent interim top of last summer is certainly nothing to write home about. The NASDAQ however, ground zero of the speculative mania, blasted higher like a ballistic missile. It was up a dazzling 55%+ from its pre-rally-4 lows by day 185 or so, but lately in recent months it has catapulted higher to a 75%+ rally-to-date gain near day 270. Wow!

While the Nikkei 225 of last decade and today's S&P 500 and NASDAQ all managed different percentage gains in their secondary cyclical-bull phases of major rally 4, their timing and patterns are remarkably similar. Since they have behaved as if reading from the same script to this point in their respective Great Bears, it certainly seems reasonable to ponder whether they will continue to follow a similar course in the weeks and months ahead.

Now I suspect that even the most belligerent skeptic would have to admit that the Nikkei-SPX parallels in rally 4 to this point have been uncanny. Provocatively, the US markets are just about to arrive at the very moment in time when the Nikkei plummeted at this stage in its own rally 4 a decade ago. From the Nikkei 225's own day 265, which was September 13th, 1993, to its day 315, November 29th, 1993, the Japanese flagship index plunged by 24%, from 21148 down to 16079.

In the States, as of Wednesday November 19th, we are now at day 281 of our own rally 4. The latest S&P 500 interim top of 1059 on November 3rd happened on day 269, only 4 days after the Nikkei 225's top a decade earlier. The latest NASDAQ interim top of 1976 on November 6th happened several days later on day 272. The Nikkei 225 really didn't start plunging in earnest until day 293, which will be early in the second week in December in current US terms.

A similar 24% plunge in the US markets from their latest interim highs at this time would drag the S&P 500 down to 800 and the NASDAQ down to 1500. Interestingly, while the Nikkei would ultimately grind far lower years later in its own Great Bear, its upcoming historical drop at this stage in rally 4 did not carry it back below its rally 4 starting point. So even if the US markets continue to track the Nikkei's course, even a relatively sharp fall does not necessarily portend a Great Bear Armageddon, just another typical bear-market downleg.

So is a big plunge in the US markets rapidly approaching? No one will know for sure until the future arrives. The eerie Nikkei-SPX parallels have been absolutely amazing to this point, but only time will tell if they will hold going forward. Regardless of if they do or do not though, you have to admit that the rally 4 inter-decade trans-Pacific congruence so far is really quite extraordinary.

Incidentally, although I don't think you can build a sound trading model on the Nikkei precedent alone, for totally unrelated purely technical reasons we launched a new short-oriented trade on the US stock indices this week.

The actual US technical signal flashed, the actual trade launched, and the logic and rationale behind our action were explained several days ago in the latest Zeal Speculator Alert for our alert-service subscribers. I will also outline this trade in the upcoming December issue of Zeal Intelligence for our monthly newsletter subscribers. Join us today to see how we are trading these surreal US markets, in terms of insight, logic, and actual trades!

I bring this point up because, totally coincidentally, long-awaited technical sell signals in the US markets are flashing independently today right at the very same time in rally 4 when the Nikkei 225 gave up its own fight! Provocative, eh? You could almost make a Twilight Zone episode out of this whole seemingly trans-dimensional comparison. It's spooky.

I am still astonished, excited, and perplexed about these eerie Nikkei-SPX parallels at the same time. I can't think of a logical reason why the US markets should precisely track Japanese precedent from a decade earlier, but obviously it is happening. Apparently there are powerful forces, perhaps speculator emotion and herd psychology, behind the scenes that are impacting each country's respective bust in similar ways at similar times. Wild stuff!

Don't be surprised if the US markets once again defy belief and head sharply lower in the coming months, once again following that apparently popular post-bubble road that the Nikkei 225 wandered a decade earlier.

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