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Japan ETFs: Compelling Plays in 2017?

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Things seem to be falling in place for the Japanese market this year. The policies of Japan and the U.S. dollar are now going in opposite directions with the Bank of Japan practicing the ultra-easy monetary policy. On the other hand, the U.S. central bank is choosing a different path on an improving U.S. economy (read: 5 Market Beating Broad International ETFs of 2016).

This has provided considerable strength to the greenback causing yen to depreciate against the U.S. dollar. CurrencyShares Japanese Yen ETF FXY lost about 9.4% in the last three months (as of January 20, 2017) while PowerShares DB US Dollar Bullish ETF UUP advanced about 3.8%. With the Fed planning to raise rates thrice this year, more strength is due for the greenback while yen is likely to see further weakness (read: ETF Winners & Losers as Dollar Hits 13-Year High).

Since Japan investing is more of a yen story, any pullback in the currency will give Japanese stocks ways to outperform. This is because Japan relies on exports considerably and a weaker currency always plays a vital role in helping Japanese companies operating abroad such as Toyota Motor Corp. (TM - Free Report) and Honda Motor Co Ltd (HMC) in repatriating more money earned in dollar terms.

In November 2014, WisdomTree discussed in a note that ‘corporate profits in Japan are more important than GDP growth’ as Japanese earnings have skyrocketed 526% cumulatively from October 1994 to October 2014 while its average economic growth was negative 0.17% during this phase.

Other Tailwinds Apart from Yen

Coming the economic front, a private measure of Japan's manufacturing sector revealed that manufacturing activity in Japan grew at the quickest clip in 12 months in December. Both output and new orders’ sub-indices experienced considerable improvement in the month.

Japan’s service sector PMI was also at an 11-month high in December. The improvement in both manufacturing and service sectors indicate that the economy – long fighting deflationary rut – is finally gathering steam. As per IHS Markit, Japan’s economy is on its way to expand 1.7% annually in Q4, the highest rate in over a year.

The Japanese prime minister’s program of a huge economic stimulus amounting to 28 trillion –– of which about 13.5 trillion yen will be in "fiscal measures” –– is also expected to boost Japanese equities this year (read: Can Japan ETFs Soar Without Helicopter Money?).

If this was not enough, the Japan government indicated that the economy is likely to grow at 1.5% in inflation-adjusted terms in the fiscal year 2017 starting April. Already the economy grew at an annualized rate of 2.2% between July and September, marking the third successive quarter of growth. The government expects the economy to log 1.3% growth in 2016.

Several Japan ETFs sport lower P/E ratios than the S&P 500-based fund SPY (17.73 times) and thus have scope for more capital gains in a favorable environment. Against this backdrop, we highlight a few Japan ETFs that could make great investing options this year. (See all Asia-Pacific (Developed) ETFs).

WisdomTree Japan Hedged Equity Fund DXJ – P/E 12.02 times

The Zacks Rank #1 (Strong Buy) fund offers exposure to Japanese dividend paying companies with a tilt toward exporters while at the same time neutralizes currency exposure. Consumer discretionary (24.6%) and industrials (22.6%) are the top two sectors of the fund.

iShares JPX-Nikkei 400 ETF JPNH – P/E 13.71 times

The Zacks Rank #1 fund follows a benchmark comprising 400 Japanese securities picked on the basis of criteria like return on equity (ROE), cumulative operating profit and market capitalization. At the same time, the fund lowers currency risk caused by fluctuations between the U.S. dollar and Japanese yen (read: 5 Currency Hedged ETFs Made Great Again by Trump).

WisdomTree Japan Hedged SmallCap Equity Fund DXJS – 11.89 times

TheZacks Rank #1 fund offers exposure to small-cap Japan equities ETFs while hedges currency translation risks.

Deutsche X-trackers MSCI Japan Hedged Equity ETF DBJP – 13.99 times

The Zacks Rank #1 fund follows the MSCI Japan US Dollar Hedged Index. Consumer discretionary (20.71%) and industrials (20.14%) are the top two sectors of the fund.

WisdomTree Japan Hedged Quality Dividend Growth Fund JHDG – 13.92 times

The Zacks Rank #1 fund looks to track an index that measures the performance of dividend-paying common stocks with growth characteristics selected from the WisdomTree DEFA Index while at the same time neutralize exposure to fluctuations between the yen and the US dollar. Consumer discretionary (29.1%), industrials (19.8%), IT (14.5%) and Telecom (13%) are the top four sectors.

WisdomTree Japan Quality Dividend Growth Fund JDG – 13.85 times

The Zacks Rank #1 fund looks to track an index that measures the performance of dividend-growing large-cap Japanese stocks. Consumer discretionary (26.1%), industrials (19.8%), IT (14.8%) and telecom (13.2%) are the top four sectors.

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