4 Strong Reasons To Buy Japan ETFs Now
U.S. stock indexes remain stuck in range this year. While stocks may still grind higher if the monetary policy stays ultra-accommodative and the economic growth picks up, many have started worrying whether their valuations look stretched now considering prospects for earnings growth.
Some investors have started looking for better opportunities in international markets. ETFs focused on Europe and Japan in particular, have seen impressive inflows this year. Stock markets in these regions are expected to continue to benefit from their central banks’ largesse.
After a lackluster performance last year, Japanese stocks have been on the rise this year and there are many reasons why they could see further gains in the coming months.
Nikkei Marches to New Highs; Yen Stuck in a Range
Japan is primarily an export oriented economy and thus its stock market usually displays a negative correlation with the yen. A weaker currency makes Japanese exports more competitive and thus as the dollar strengthens against the yen, stocks of Japanese exporters go up. But the inverse relationship seems to have broken this year.
While the yen has been stuck in a tight range, almost unchanged versus the U.S. dollar year-to-date, Japanese stocks have been marching higher. The Nikkei index touched 20,000 on April 23, after more than 15 years. It’s up more than 12% this year.
One of the reasons for the surge is the prospect of additional stock purchases by the massive Japanese pension fund. During the fourth quarter of 2014, the pension fund was the largest buyer of Japanese stocks. And it’s not just the pension fund, the Japanese postal bank and even the central bank are buying stocks, and these purchases are expected to continue, boosting share prices.
The yen seems to be in a waiting mode as of now, but launch of additional easing in Japan or signs of a lift-off of rates in the U.S. would definitely weaken the currency, benefiting exporters in turn.
More Easing on the Cards?
Authorities in Japan continue to struggle to revive the economy. With launch of massive easing program about two years back, Japanese stocks had surged and the currency tumbled. But the economy slipped into recession after the sales tax hike last year. As a result, the government had to postpone the second tax hike. Though the economy emerged from recession, the growth continues to be sluggish.
Recent Tankan survey by the Bank of Japan revealed that the companies are still reluctant to spend due to weak domestic and Asian demand. Lower oil prices have put pressure on inflation, negating BOJ’s efforts to stimulate inflation.
BOJ recently pushed out the timeline for reaching their long-held inflation target of 2%. They now expect the target to be achieved around the first half of fiscal 2016, six months later than the previous forecast.
Many market analysts believe the BOJ will announce further easing measures in July or October due to faltering economic recovery.
Rising Corporate Profits
Another reason to be bullish on Japanese stocks is the rising profitability of Japanese companies. With lower yen, cheap oil prices and recovery in domestic demand, Japanese companies are expected to report solid profit growth this year as well.
With improving bottom-lines, these companies are also increasing their dividends and buybacks, which should further support stock prices. Japanese companies have accumulated a lot of cash on their balance sheets and are expected to spend more on investments, dividends and buybacks in the coming years as real yields stay close to negative.
Japanese Stocks Still a Bargain?
Despite recent surge, Japanese stocks trade at 14.7 times forecast earnings, below their 10-year average of 15.8. Looking at the cyclically adjusted price/earnings ratio (CAPE) or Shiller P/E—Japanese stocks are trading at a multiple of 23.7 as of March more than 20% below than the historical average of 34.4. Considering superior earnings growth potential of Japanese companies, these valuations look very attractive.
Best ETFs to Consider
In view of the reasons discussed above, we strongly believe that investors should consider investing in Japan ETFs. Additionally, adding some international flavor to the portfolio provides diversification benefits and boosts long term risk adjusted returns.
WisdomTree Japan Hedged Equity Fund (DXJ - ETF report) is an excellent way to profit from the rise in Japanese stocks while hedging the currency risk in case the yen moves lower. Top holdings include well known Japanese exporters Toyota (TM), Mitsubishi (MSBHY), Nissan (NSANY) and Honda (HMC). It charges an expense ratio of 0.48%. DXJ is up more than 17% year-to-date.
Another great ETF worth a look is Deutsche X-Trackers MSCI Japan Hedged ETF (DBJP - ETF report), which follows a similar strategy and is also slightly cheaper, with an expense ratio of 0.45%. Toyota, Mitsubishi, and Softbank (SFTBY) are among the top holdings. DBJP is up more than 15% this year.
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