Japan Market: Why Land Of Rising Sun Can Shine More

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Japan's stock market rallied to a fresh high this week, and the bull has much more room to run, investment strategists say.

After falling for more than two decades, the market may be truly recovering, thanks to expectations that aggressive monetary policy will stimulate the world's third-largest economy.

Trading in the U.S. stock market , iSharesMSCI Japan Index ( EWJ ), the largest ETF tracking the island nation, surged to an intraday high of 10.53 this week -- the highest price since August 2011 after rising five months in a row. EWJ has climbed 8% this year vs. 4.75% for iSharesMSCI EAFE Index ( EFA ), tracking developed foreign markets.

WisdomTree Japan Hedged Equity Fund ( DXJ ), which hedges exposure to the yen, vaulted to its highest price since September 2008 after climbing for nine straight months. It's added nearly 18% year to date.

Japan's stock market owes its outperformance to the depreciating yen. The MSCI Japan Index rallied 9% year to date in dollar terms, according to MSCI. When measured in yen, it's rallied 21.2%.

Traders have dumped the currency en mass in anticipation that the new government, led by Prime Minister Shinzo Abe, will pressure the Bank of Japan to loosen monetary policy to stimulate the economy.CurrencyShares Japanese Yen Trust ( FXY ), tracking the yen against the dollar, has fallen nearly 10% this year and nearly 15% in the past 12 months; $1 bought 96.04 yen as of Tuesday.

David Kotok, chairman and chief investment officer at Cumberland Advisors in Sarasota, Fla., says the yen will trade over 100 to the dollar, then to 115, further juicing Japan's stock gains. He's investing in Japan via WisdomTree Japan Hedged Equity.

"Japan is on a tear. After two decades of financial repression and deflationary suffering, a new government has changed policy in a fierce way," Kotok wrote in a client note.

Japan's market is trading at about 16 times earnings, more expensive than other markets, but low relative to its historical average, says Alec Young, global equity strategist at S&P Capital IQ.

At its bubble peak in the late 1980s, Japanese stocks traded as high as 40 times earnings. The weak currency has boosted Japanese exports, prompting companies to revise earnings upward because previous forecasts were based on a stronger yen, Young says.

A major investment risk is if investors switch suddenly from risk-on mode to risk-off, when investors flock to the yen as a safe haven. That would drive the yen up against foreign currencies while sending stocks the opposite way.

In addition, Japanese leaders could fail to implement new policies as the market expects. The recent rally has been mostly driven by hopes that aggressive policies will lead to fundamental economic improvement, says Young. He believes Japan's market could rally an additional 5% to 10% by year's end and recommends investors wait for a pullback from the new highs before entering.

The Bank of Japan aims to boost inflation to 2% and has pledged to buy more bonds. Decision Economics projects the country's economy will expand more than 3% in 2014.

"Much more will be done after the new central bank Gov. (Haruhiko) Kuroda takes charge," Decision Economics wrote in a report released Tuesday. "Some surprising and strong moves toward easier money (policy) will be viewed as positive for Japan's prospects but with concern by Japan's trading partners."

Chart Action

Japan's stock market spiraled toward a long-term downtrend in 1990 as the country suffered from deflation. IShares MSCI Japan Index trades 37% below its 2000 high, while most countries long surpassed their highs from that year.

IShares MSCI Japan has gained only 52% from its 2009 bear-market low, while most markets have at least doubled. On Tuesday it traded 3% above a 10.09 buy point in a long cup-with-handle base. It has to spike an additional 49% to regain its 2006 high of 15.55.

WisdomTree Japan Hedged Equity, the top performer of its kind this year, broke out of a nine-month, long saucer base in January. It's extended 15% from a 37.31 buy point.

It sports an IBD Relative Strength Rating of 85 -- one of the highest among foreign ETFs -- and a perfect A+ Accumulation/Distribution Rating. That indicates it's been rising faster than 85% of the market in the past 12 months and institutional investors are loading up on shares and not selling.

It has to rise an additional 37% to recapture its pre-bear market high of 58.97.

Japan ETF Returns Year To Date And Past 12 Months

CurrencyShares Japanese Yen Trust ( FXY ): -9.9% ytd; -14.7% one year.

IShares MSCI Japan Index ( EWJ ): +8.0% ytd; +6.6% one year.

SPDR Russell Nomura PRIME Japan ( JPP ): +8.3% ytd; +7.1% one year.

SPDR Russell Nomura Small Cap Japan (JSC): +8.4% ytd; +7.2% one year.

WisdomTree Japan Hedged Equity Fund ( DXJ ): +17.9% ytd; +21.08% one year.

WisdomTree Japan SmallCap Dividend Fund (DFJ): +6.5% ytd; +6.4% one year.

Follow Trang Ho on Twitter @TrangHoETFs .

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

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

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