This article was published in Business Times’ column “Chart Point” on 13 November 2017.

TOPIX Monthly chart                                                                                                                              Source: Bloomberg, PSR

Amid the soaring Japanese equity market, the long-term price pattern of the TOPIX reveals a major obstacle ahead. With the Bank of Japan being the last few central banks to have any plans to tighten monetary policy, the excess liquidity continues to drive the Japanese equity market higher, and the current bullish momentum appears unrelenting. Both the Nikkei 225 and Tokyo Stock Price Index (TOPIX) soared to a new 52-week high with the Nikkei 225 leading the way as it has already surpassed 23% above the 2007 high of 18,300 points while the TOPIX is only currently testing the 2007 high of 1823 points. TOPIX is a capitalization-weighted index of all firms listed on the first section of the Tokyo Stock Exchange.

The price action becomes more interesting as the TOPIX approaches its multi-decade top between 1708 to 1823 points. The 1708 point was first established in September 1993. Since then, it has been a stumbling block for the bulls. There were six prior attempts by the bulls to take price higher above the 1708 roof, but every single try was rejected aggressively shown by the down arrow. During the housing boom period of 2000, the TOPIX managed to break above the 1708 critical resistance in February 2007. However, the bullish momentum only lasted for five months before the Global Financial Crisis (GFC) top formed at 1823 points. As we edge higher from here on, the TOPIX will very likely face some rejection off the GFC high of 1823 points and enter into a period of correction. The unrelenting bullish momentum since August 2016 should take a breather soon.

Historically, the average correction that follows after the reversal at the 1708 ceiling is -39%, and the largest drawdown happened in the GFC where the TOPIX crumbled -61% from the 1823 peak to 698 trough. Adding another layer to the analysis by looking at the Relative Strength Index (RSI) also suggests a high likelihood of a correction soon. RSI measures momentum to identify overbought or oversold condition. Reading above 70 represents overbought condition while reading below 30 represents oversold condition.

Out of the six occasions where the market correction happened around the 1708 resistance area, four occurred with an overbought RSI above 70. To make matters worse, the more severe corrections happened when the RSI was overbought. The Dot-com bubble era in the late 1990s took the RSI to a high of 71 in December 1999. Four months later, the Dot-com high was formed as the 1708 ceiling kept a lid on price which then resulted in a -56% drawdown over the next three years. The GFC high also occurred with an overbought RSI as the 1708 ceiling weigh down on price. A similar high of 71 on the RSI was formed in February 2007 where the TOPIX took five months to top out. The GFC led a crash of -61% in the TOPIX.

Fast forward to present, the recent bullish surge has once again brought the TOPIX back to the critical resistance area between the 1708 – 1823 points. Moreover, the move higher has also pushed the RSI into overbought condition to 73. History does not repeat but often rhymes. As the TOPIX edges closer to the upper range of 1823 point of interest with the overbought RSI, there is a high likelihood of a correction around the corner. Watch this area closely to see if the 1708 – 1823 ceiling holds up or not where a correction of up to -20% is possible.