Why Are Japanese Equities About To Stage Their Next Big Leg Up

Since the beginning of the year, Japanese equities have been one of the worst performing developed markets. Despite the most expansionary monetary policy in the world, Japanese markets plummeted by the greatest percentage in the first seven months of the year and showed no signs of recovery. However, from the second half of the summer, the dynamic of the market started slowly turning back to the bullish territory.

Looking at the chart of the major currency pair dollar yen, one can notice that the dollar successfully defended key technical support at 100 yen per dollar and jumped above the EMA 200 in a very short period of time. The long-term trend line is also clear. Since Mr Kuroda assumed the office of the Governor of the BoJ in March 2013, the value of the yen started vanishing at an accelerating pace. Hence, in the light of the massive monetary stimulus, the recent appreciation of the yen can be seen as a technical correction in the main – long-term – trend.

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And with a little chance of a twist in Japan`s CPI, the likelihood of a significant change in the BoJ`s policy towards a more restrictive stance is almost zero. Even though the central bank used all its available means to fight the long-lasting deflation malaise, consumer prices still show no signs of recovery. Last month, the primary gauge of Japan`s inflation fell 0.4 percent in comparison with the same month a year earlier, which testifies that the BoJ`s 2% sustainable inflation target is still far away.

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Where and when will all this end? Well, attempting to time the consequences of the Japanese monetary experiment is out of the capabilities of any human being, but one thing is almost sure – the yen is at the very beginning of a long journey to being the SDR basket`s weakest currency.

Source: Mish`s Global Economic Trend Analysis

On the other hand, there are some positives of the story as well. As exports account for almost a fifth of Japan`s GDP, a weaker yen will perceptibly contribute to higher earnings of Japan`s largest exporters such as Toyota (OTCPK:TOYOF), Honda (NYSE:HMC)(OTCPK:HNDAF), Nissan (OTCPK:NSANY)(OTCPK:NSANF), Panasonic (OTCPK:PCRFY)(OTCPK:PCRFF), Sony (NYSE:SNE)(OTCPK:SNEJF) or Hitachi (OTCPK:HTHIY)(OTCPK:HTHIF).

An alternative way to picking particular stocks might be a purchase of some Japan-oriented exchange-traded fund. Actually, this approach is presumably the most convenient as with several funds, you do not have to hedge the yen exposure by yourself.

According to etfdb.com, there are 39 Japan ETFs, of which 18 are partially or fully hedged against adverse market movements in the dollar yen currency pair. The most popular ETF by total assets under management is the WisdomTree Japan Hedged Equity Fund (NYSEARCA:DXJ), but it may be not the best way to invest in Japanese equities as the fund has been underperforming both main Japanese benchmarks – the Nikkei 225 and the Topix 100 – by a large margin. Based on a quick graphical comparison on Google Finance, I find DXJ`s younger peer – the WisdomTree Japan Hedged SmallCap Equity Fund – a lot more attractive.

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Source: Google Finance

To sum up, I believe that the recent performance of both Japanese equities and the yen can be marked as corrections in the long-term trend. If no new circumstances come to light, there is no reason to believe that the Japanese bulls are losing breath. As always, feel free to share your thoughts.

Disclosure: I am/we are long DXJS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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