Japanese ETFs: Technicals and Fundamentals


Compared with ETFs from fast-growing Asian economies like China and Korea, returns from Japanese ETFs have been disappointing. But Japanese funds weathered the economic storms of 2008 and 2009 better than other ETFs in Asia. Japan is widely seen as stable but projected to have anemic growth in the years ahead. Investor expectations are correspondingly low. Is this an opportunity?

There are a number of good options for ETF investors in Japanese including one of the oldest and largest ETFs, the iShares MSCI Japan Index (NYSEArca:EWJ). EWJ, and a competitor fund the iShares S&P/TOPIX 150 Index Fund (NYSEArca:ITF), are heavily concentrated in large cap companies. There are two good ETFs with a small-cap focus available for Japan: iShares MSCI Japan Small Cap Index Fund (NYSEArca:SCJ), SPDR Russell/Nomura Small Cap Japan ETF (NYSEArca:JSC). All four funds have comparable expense ratios around 0.5%.

The Japanese market tends to be more heavily concentrated in industrial material and consumer goods compared to the US markets. These ETFs reflect this. About a quarter EWJ's holdings for example are in industrial materials and a quarter are in consumer goods. Financial and business services make up a quarter of the fund and the final quarter is diversified into healthcare, utilities, energy, and software etc.

Technically Japan looks tempting. The chart below shows the 40-year performance of the Nikkei 225:

The Nikkei peaked in mid-December of 1989, at just under 40,000. It appears to have bottomed twice: in April 2003 and February 2009, at about 7,500. In terms of the historical movement of the Nikkei, today's level is not far from February's 7500 level. Many technicians believe that a chart with a "double bottom" provides a level of price support.

But on a fundamental basis there are problems in Japan. At around 200% of GDP, Japan's debt is larger than any other major advanced nation, and (as measured as a ratio of GDP) more than twice U.S. levels. It does not appear that Japan will grow its way out of this debt. In fact, the IMF predicts that the Japanese economy will shrink by 6% in 2009, implying an 8% output gap, the largest of any major industrialized economy. This, of course, will raise debt-to-GDP ratios.

The Japanese economy is heavily dependent on foreign demand, particularly for manufacturing exports. This is attracting investor scrutiny as deleveraging and reduced global demand hit the Japanese squarely. With patterns of world consumption increasingly in flux, the Japanese government is once again trying to boost local demand. But the Japanese are historically inclined to save, particularly when they see unemployment. While still low by Western standards, it is on the rise and in 2010 is expected to top 5% for the first time since 2003.

Despite trading near an historic low, the Japanese markets are arguably still expensive. The Nikkei's P/E is about 17, compared to 10.5 for the S&P. Few currently expect a change in the profit picture. The Tankan business confidence index showed -58 in March 2009, a 30-year low.

Investors in Japanese ETFs finally should be aware of the impact of foreign exchange. 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 97, which means that on an historic basis the yen is strong. If the dollar strengthens against the yen, Japanese ETFs will lose value in dollar terms . Right now the yen looks like a good place to hedge the risk of dollar inflation, but if dollar inflation does not appear the yen could get a lot weaker. For those wanting the solidity of the yen but not the Japanese economy, WisdomTree Dreyfus Japanese Yen Fund (NYSEARca:JYF) invests in money market securities denominated in yen. For those wanting exposure to the Japanese economy without foreign exchange risk, a long position in a Japanese ETF like EWJ combined with a short position in Japanese currency ETF like JYF will hedge away yen exposure.

A list of Japanese ETFs and their expense ratios follows:

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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