Japanese ETFs: Stagnation


The Japanese economy has stagnated for two decades. The most important Japanese ETF, the iShares MSCI Japan (NYSEArca:EWJ), debuted in the Spring of 1996 at just over $14 a price-adjusted share. It trades today at around $10, a 30% haircut. Despite this long period of stagnation-- the lost decade in Japan that some have taken to calling the lost generation-- there are few signs of an improvement.

Recently Japan has been keeping pace with other major markets. The chart below compares EWJ with the iShares MSCI EAFE Index (NYSEArca: EFA), a broad based ETF covering Europe, Australia and the Far East, and the U.S. domestic benchmark Standard and Poor's Depositary Receipts (NYSEArca:SPY) over the last five years:

But over the very long term, with the rest of the world's markets up 1000% or more during this period, Japan has gone nowhere. The chart below shows the Japanese Nikkei, from 1984 to the present:

As the chart shows, since bolting up in the 1980's Japan has been falling. Today it trades at about the same level as 1984. What happened? Japan has several seemingly intractable problems.

Its chief problem is arguably a lack of domestic demand. Consumer spending represents 55-60% of GDP in Japan compared to 70 % in the United States. This historical pattern has not changed since the bursting of Japan's real estate bubble in the late 1980s when consumer growth collapsed along with the Nikkei. The Japanese, despite low interest rates, have been unsuccessful at spurring demand.

Without significant domestic demand, Japan is dependent on exports for growth. The world-wide crisis hit Japan, which had just started to emerge from a recession, hard. By some estimates 30% of factory capacity in Japan is idle. Although there is demand for Japanese goods in the U.S. and Europe, export growth has shifted to China, with its advantages of low labor cost and a cheap currency. In addition, most Japanese businesses are mature. They face significant competition from European and U.S. companies. The largest holding in EWJ, for example, is Toyota, which has struggled recently to keep, let alone grow, its market share.

Japan has challenging demographics. Over 20% of its population is over the age of 65. This is projected to reach 30% by 2030. Conventional thinking is that an aging population is less productive and will require more expensive care. Japan's working-age population today is about 80 million. By 2030 it will be about 70 million. Some forecasters believe that Japanese will work until they are older than 65 helping to offset this trend, but even if they do, this will not eliminate the demographic problem.

Japan has a lot of debt. Japans debt is close to 200% of GDP. The US owes more money than Japan of course and the US has enormous debt problems. But measured as a percentage of GDP, US debt is less than half Japanese levels. High public debt retards economic growth. This makes it difficult for Japan to grow its way out of debt. The Japanese economy grew at an annualized rate of 0.9% in the fourth quarter of 2009. The current IMF forecast for growth of the Japans economy is 1.8% in 2010 and 2.5% in 2012, nowhere near enough to make even the slightest dent in its public debt.

Japanese rates are low, making it difficult to stimulate the economy. Japan's benchmark interest rate is 0.1%. With monetary policy thus hemmed in, Prime Minister Yukio Hatoyama has announced a 7.2 trillion yen stimulus plan. This may help the world's second largest economy to keep pace, but will further add to its debt. This year or next China will surpass Japan as the world's second largest economy.

For investors in Japanese ETFs there is another concern. Japanese ETFs hold companies whose value is denominated in yen. Owning a Japanese fund therefore is a bet on the yen. USD/JPY is currently trading at about 92, which means that on an historic basis the yen is strong. If the dollar strengthens against the yen as it has been recently, Japanese ETFs will lose value in dollar terms. Because current debt levels are so high in Japan some investors believe that the yen is at risk.

So what's there to like? One thing is that Japanese funds weathered the economic storms of 2008 and 2009 better than other ETFs. Japan is not seen as unstable. It is simply projected to have anemic growth.

Japan never recovered from the asset and property bubble of the 1980s. Is this a cautionary tale for other first world economies like the United States? The answer is maybe. There are many lessons to be learned from Japan. Japan despite its stagnant economy has done a remarkable job handling massive amount of debt. The US and European policy makers should study Japan.

The following are a list of Japanese ETFs and their expense ratios. Of the ETFs listed below, EWJ is by far the largest. WisdomTree's Small Cap Dividend Fund (NYSEArca:DFJ) has about 115 Million is assets, the rest of these ETFs have less than 100 Million in assets.

Large Cap Japan

Large Cap Japan

iShares MSCI Japan Index Fund ( EWJ ) , 0.52%

iShares S&P/TOPIX 150 Index Fund ( ITF ), 0.5%

SPDR Russell/Nomura PRIME Japan ETF ( JPP ), 0.5%

Small Cap Japan

Small Cap Japan

iShares MSCI Japan Small Cap Index Fund ( SCJ ), 0.53%

SPDR Russell/Nomura Small Cap Japan ETF ( JSC ), 0.56%



WisdomTree Japan SmallCap Dividend Fund (NYSEArca:DFJ), 0.58%

WisdomTree Japan High-Yielding Equity Fund (NYSEArca:DNL), 0.58%

WisdomTree Japan Total Dividend Fund (NYSEArca:DXJ), 0.48%



WisdomTree Dreyfus Japanese Yen Fund (NYSEARca:JYF), 0.35%



ProShares UltraShort MSCI Japan ETF (NYSEArca:EWV), 0.95%

Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds .

Jonathan Bernstein has been writing about ETFs since 2003 and is the author of Sector Trading: A Year in Exchange Traded Funds . Jonathan Bernstein Sector Trading: A Year in Exchange Traded Funds

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , ETFs



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