With so much investor attention on the post-election "fiscal
cliff," the eurozone debt crisis and the once-in-a-decade change of
leadership in China, investors may be overlooking some big
developments in Japan, the world's third-largest economy.
Since late September, the yen has weakened substantially due to
increased speculation that the Bank of Japan (BoJ) will come under
tremendous political pressure to embark on a massive quantitative
easing program to weaken the yen and end deflation, which has
plagued the country for two decades.
Exacerbating the yen's fall during the past few days is Shinzo
Abe calling on the BoJ to get aggressive on its current stimulus
and begin an unlimited quantitative easing (QE) program to weaken
the yen and reset its inflation target from the current 1 percent
to 3 percent.
Abe is a former prime minister, the current leader of the
Liberal Democratic Party (
) and, quite possibly, about to again become prime minister.
Indeed, Abe's LDP is currently leading the polls for next
month's elections, and if it wins-and if Abe is serious about his
intention to ramp up monetary easing-a new day may be about to dawn
in Japan's battle against deflation since its real estate and stock
market unraveled more than 20 years ago.
This should be positive for Japanese equities, which have
rallied strongly in the past few days, as the yen got punished.
That's because a large component of Japan's economy is
export-driven, and there has been an inverse correlation between
yen weakness and equity strength in recent years.
All this means that should Abe become prime minister and install
an ultra-dovish governor at the helm of the BoJ who would zealously
ramp up QE, investors should keep an eye on a number of
I've long felt that with the yen sitting in the mid-to high-70
range, the way to play a rebound in Japan is through a
currency-hedged product like the WisdomTree Japan Hedged Equity
Fund (NYSEArca:DXJ) over a nonhedged product like the $4 billion
iShares MSCI Japan Index Fund (NYSEArca:EWJ).
DXJ hedges its exposure to the yen by shorting yen futures and
forward-contracts. It doesn't necessarily carry a net short-yen
exposure; rather, it neutralizes its yen exposure.
So, while DXJ's short-yen exposure won't directly juice the
fund's returns as the yen falls, investors in DXJ will get a purer
equity exposure. That said, if the yen continues to weaken,
Japanese equities should indirectly get a boost, which holders of
DXJ will enjoy.
WisdomTree also recently announced a change in its index
methodology for DXJ. Effective Nov. 30, 2012, DXJ will implement a
filter in its methodology to place a heavier focus on multinational
companies poised to benefit from a weaker yen.
Another currency-hedged product to keep an eye on is the db-X
MSCI Japan Currency-Hedged Fund (NYSEArca:DBJP), which tracks the
same MSCI index as EWJ, but with a currency-hedged feature.
In the meantime, investors with their Japan equity exposure
parked in the popular EWJ are exposed to currency risk. That cuts
both ways:They're negatively affected by any losses in the yen, but
of course benefit when the yen rises.
Investors looking to play yen weakness directly without equity
exposure can short the CurrencyShares Japanese Yen Trust
(NYSEArca:FXY) or go long the ProShares UltraShort Yen ETF
I prefer shorting FXY over going long YCS, since I'm more of a
long-term bear on the yen. With interest rates near zero in Japan,
FXY hasn't paid dividends, so short-sellers haven't been on the
hook for any payouts due the actual owners of the shares that have
been borrowed for shorting.
Plus, not only do leveraged products have a negative compounding
effect over the long haul, YCS is structured as a commodities pool,
as it gains its exposure using futures contracts.
This means mark-to-market tax consequences every year, whether
you sell or not-and K-1 forms. Not for me, thanks; I like to keep
my taxes simple.
But to each his own. Some investors don't care about K-1s and
would prefer YCS' tax-rate benefits. Specifically, 60 percent of
its capital gains or losses are taxed as long term, while 40
percent are taxed as short term. In comparison, all of FXY's gains
are taxed as ordinary income for FXY.
If the LDP takes control next month and the BoJ goes all-in the
way Swiss National Bank did in its efforts to weaken the Swiss
franc, things should get interesting in Japan.
But investors need to keep a few things in mind. On numerous
occasions, the yen has been pummeled on speculation of more action
from the BoJ, only to surge once again after the shorts were
disappointed by a smaller-than-expected stimulus announcement.
If the U.S. "fiscal cliff" situation worsens, or the eurozone
debt crisis rears its ugly head again, the BoJ may have to fight
some strong market forces pushing the yen stronger, as investors
pile back into the yen as a safe-haven currency.
That's ironic, to say the least, since Japan's debt-to-GDP
ratio, currently well over 200 percent, is higher than any nation
in the world, even higher than Greece. That said, comparing an
industrial powerhouse like Japan to Greece is more than a little
In any case, the recent announcements point to a real
possibility for some structural changes in Japan's monetary policy
in the coming year.
The good news is that there are plenty of ETF products in which
you can take advantage of further yen weakness in such a
At the time this article was written,
the author held a long position in DXJ and a short position
Contact Dennis Hudachek at firstname.lastname@example.org.
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