It has been a familiar battle cry for Japan bulls for what
feels like ages now: Japanese equities are cheap on a valuation
basis. The first problem is, due to unfavorable demographics and
a severe bout with deflation, Japanese equities have been in a
bear market for well over two decades. The second problem has
been the soaring yen, which punished Japanese exporters.
"The last five years have been especially difficult-from the
global recession and financial crisis to the earthquake and
tsunami of 2010-and were compounded by an ever-rising yen that
made Japanese exports less competitive in the global
marketplace," WisdomTree Research Director Jeremy Schwartz said
in a recent note.
Over those five years, the iShares MSCI Japan Index Fund
(NYSE:
EWJ
), the largest Japan ETF by assets, has lost nearly 34 percent of
its value. As measured by
ETFs
, Japanese equities have had almost perfect inverse correlation
to the yen. Over the past five years, the CurrencyShares Japanese
Yen Trust (NYSE:
FXY
) has jumped 33.5 percent.
Still, there is a value case that can be made for Japan, the
world's third-largest economy. Of course, the yen will play a
part in any scenario involving the Japanese economy, good or bad,
but there were some positive signs earlier this year.
"As one piece of highly anecdotal evidence, just look at the
first quarter of 2012-when the yen weakened 7% and Japan was the
best-performing country in the developed world markets,"
Schwartz noted
.
In the past three months, FXY has lost more than four percent
as traders have begun pricing in a victory for Shinzo Abe and his
Liberal Democratic Party in Japan's December 16 elections. Abe,
himself a former prime minister, has adopted a simple campaign
platform. Much as U.S. politician would run for president
pledging to reduce taxes, Abe has vowed to weaken the yen.
After a third round of quantitative easing was announced by
the Federal Reserve earlier this year, some U.S. investors joked
about "QE-ever." Japan could really go down that path as Abe's
political talk has included terms such as "unlimited monetary
easing." That explains why the ProShares UltraShort Yen (NYSE:
YCS
), a double-leveraged inverse play on the yen, has rallied three
percent in the past month.
"Many of the nation's exporters have started to see their
stocks react very positively on speculation that the yen's very
outsized strength over the past five years may be set to reverse
course with an Abe victory in the December 16 election," said
Schwartz.
Investors looking to participate in Japan's upside while
reducing potential yen-induced headaches should consider the
WisdomTree Japan Hedged Equity Fund (NYSE:
DXJ
). December marks the first month that DXJ's index will trade
with a geographic filter to remove companies that derive the bulk
of their revenue from Japan.
The index also now caps sector weights at 25 percent.
Industrial names currently represent over 24 percent of DXJ's
weight while discretionary, technology, health care and materials
names also garner double-digit allocation.
As a way of trimming yen exposure, DXJ has proven even more
profitable than YCS as the former has surged four percent in the
past month. Investors are taking notice. DXJ
had $516 million in assets under management
as of mid-November. The ETF started trading today with nearly
$648 million,
according to WisdomTree data
.
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