A version of this article appeared as a column in Saturday’s National Post.
We live our days in awe of the Middle Kingdom. But once it was the Land of the Rising Sun that kept us awake at nights. Will Japan ever return to its economic glory-days? Unlikely, however it may offer a shorter term buying opportunity, especially for the contrarian investors out there.
Back in the 1970s and ‘80s, Japan was the world’s next economic superpower, just on the cusp of surpassing the US with its lean, just-in-time manufacturing and its blue-uniformed workers. The pinnacle came in 1989 when bland Tokyo office towers could be traded for the Rockefeller Center and the Nikkei 225 stock index hit 39,000. As with all bubbles, Japan’s property and stock markets crashed and the country has never been the same.
Japanese government debt is more than double the size of Japan’s total GDP, which itself is expected to fall slightly this year. Japan is the only major economy experiencing deflation, as its currency has strengthened more than commodity prices. Even its population is deflating: it is expected to fall by about 350,000 people this year as deaths outnumber births. Immigrants need not apply.
Not exactly a compelling case but there are two solid reasons for equities to experience a rally over the short term. First, to cope with the Tohoku disaster, monetary policy has eased and government spending has increased: both are good for stocks. Second, low stock valuations are attracting foreign interest.
Much of the blame for Japan’s lackluster performance over the last two decades can be laid squarely on the Bank of Japan. Unlike its American counterpart, which aids and abets speculative bubbles, the BoJ is the world’s fiercest bubble fighter. While it has kept nominal interest rates low, real rates – the nominal less the inflation rate – has been relatively high. This excessively tight monetary policy has restrained economic growth at about 1% per year since the 1990s. To ease the financial crisis of 2008, the BoJ released a miserly US$60 billion by buying government treasury bonds. Compare that to the $600 billion the Federal Reserve injected in its second round of quantitative easing which ends this month.
The earthquake and tsunami disaster in March is forcing a re-think. Following the disaster, the BoJ moved quickly to provide Japanese banks with fresh liquidity, offering $265 billion over the course of a few days. It also doubled its bond purchases to $120 billion to add longer-term liquidity. The government also stepped up with about $50 billion for rebuilding efforts, less than half the lowest estimate for the rebuilding, but with possibly more to follow.
Currency movements are also forcing the BoJ’s hand. At about 81 to the US Dollar, the Yen is the strongest it has been in 40 years, and up about 25% in just the last three years. In response, the BoJ has issued more Yen to prevent the currency from strengthening even further. The Japanese equity market, with its high proportion of exporters, benefits both from the weaker Yen and from the increase in money supply. As in all countries, equity performance is linked to monetary policy. The looser, the better for stocks. The challenge is to get the policy just right to avoid the bubbles.
In addition to the monetary background, Japanese equity valuations are attractive. Price-to-Earnings are about 14.4, in line with US large caps; Price-to-Book is at 1, less than half the US level. The valuations have attracted foreign investors who have invested more than $60 billion in Japanese equities this year.
There are two Japanese ETFs to consider: the iShares MSCI Japan Fund (EWJ) and the WisdomTree Japan Hedged Fund (DXJ). Both hold over 300 companies and both have reasonable MERs. EWJ is by far the larger and more liquid of the two. However, DXJ is currency hedged to the US dollar. With both currencies at historic extremes, I would expect that the USD will strengthen and the Yen will weaken over the coming months. This will put DXJ at an advantage.
|52 Week High||$41.21|
|52 Week Low||$33.50|
|Avg Daily Volume||0.35 Million Shrs|
|Avg Daily Volume ($)||$12.27 Million|
|Total Market Cap||$447.84 Million|
|ETF Annual Fee||0.48%|
|ETF Trading Currency||USD|
|ETF FX Exposure||USD|
|Correlation to S&P 500||74.6%|
|Return to Risk Ratio||-0.91|
|Use of Leverage||No|
|Use of Futures||No|
|6 month Return||-7.17%|
|1 Year Return||-5.73%|
|2 Year Return||-7.76%|
|3 Year Return||-22.87%|
|Dividend Yield (TTM)||1.28%|
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© 2011 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.