According to the Wall Street Journal, as long as the rating
stays above âA,â pension funds can continue investing in
Japanese government bonds without any trouble. Moodyâs new rating
is now at the equivalent level of previous ratings issued by
Standard & Poorâs and Fitch. Moodyâs last downgrade of
Japan was in 2002 and its outlook on Japan is now stable. However,
S&P and Fitch both have a negative outlook, meaning that
further downgrades could be coming.
When the S&P downgraded the U.S., it sent stock markets into
turmoil. Even just talking about a potential U.S. downgrade roiled
the markets. In case you havenât been watching your portfolio
bounce around, see SPYâs daily NAV returns below:
SPY Daily NAV Returns, 8/1/11-8/23/11
So, now that Japan has joined the countries getting downgraded,
how will that affect you? I drew up a table of correlations between
the iShares MSCI Japan Index Fund (NYSEArca:EWJ) and a collection
of regional funds you might have invested in:
- U.S.:SPDR S&P 500 (NYSEArca:SPY), with a 0.92 correlation
- World ex-US:iShares MSCI ACWI ex US Index Fund
- Europe:iShares Europe 350 Index Fund (NYSEArca:IEV):0.90
- Asia ex-Japan:iShares MSCI All Country Asia ex Japan Index
The lowest correlation, at 0.90, is between Japan and Europe.
That said, any statistics teacher can tell you that correlation
does not imply causality; namely, that a movement in EWJ does not
a movement in SPY. They merely tend to move in the same direction
at the same time.
So instead, I ran some regressions to determine what percentage
of the movement in each of those regional ETFs can be explained by
movement in the Japanese ETF. Itâs still quite a lot, and we can
all thank global trade.
R-Squareds of Regressions of Regional ETFs On Japan
Again, the lowest results are in the European fund and the
highest are in the Asian and global funds.
Donât just take my word for it, though. Letâs look at what
happened when the Japanese earthquake and tsunami hit in March.
EWJ obviously tanked. More important to my point, though, is
that everyone else got hit too.
So, to return to Moodyâs lowering its rating on the Japanese
government, itâs easy to assume that a slight downgrade to a
generally strong country doesnât matter much. And who knows, it
might not. Or it might.
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