Japan has long been enjoying beneficial easy money policies, which have put the economy on a growth path. Japanese markets saw a stellar run in 2017 with equities riding back to heights last seen in 1991 (read: Japan ETFs Will Continue Their Stellar Run in 2018).
Though Japanese inflation is yet to pick up meaningfully, an uptick in domestic demand should translate into higher growth ahead. As per the preliminary estimate, the Japanese economy grew 0.1% sequentially in the final quarter of 2017, after a 0.6% expansion in the previous period and a little lower than the market consensus of 0.2% growth.
A slack in business spending offset an uptick in private consumption. The economy nevertheless grew for eight consecutive quarters, the longest streak since a 12-quarter expansion ended in 1989 (read: Japan ETFs in Focus as GDP Grows for 8 Straight Quarters).
Against this backdrop, we highlight three reasons that could make Japan ETFs a buy.
Pickup in Inflation?
Vanguard Group recently indicated that “a pickup in Japanese prices will boost the country’s equities, unlike in the U.S. where fears over inflation sent shares tumbling into a correction.”
Consumer prices in Japan increased 1.0% year over year in December of 2017, from a 0.6% nudge-up in the previous month and slightly below expectations of a 1.1% increase. This was the highest rate since March 2015.
The likelihood of higher prices and cheap valuations make Vanguard “most positive” about Japanese stocks.
Improving Corporate Earnings
The global economic recovery led to higher earnings in corporate Japan, especially in the area of electronics, machinery and trade. Record earnings at foreign subsidiaries helped Japanese companies outperform in 2017 as “substantial investment abroad allowed them to tap into foreign markets and supplement exports.” Income from direct foreign investments grew 20% year over year to a record 12.71 trillion yen in 2017.
Japan’s stocks appear to have cheaper valuation too. As per a source, in 2013, these stocks were 60% pricier than the American ones, going by the EV/EBITDA multiple. But currently, Japanese stocks are trading at an EV/EBITDA ratio of 8.4, which is 51% cheaper than the ratio in the United States. The article went on to explain that Morgan Stanley found that Japanese market’s valuation is near an all-time low compared to the rest of the world.
Japanese companies are cash rich too. These started concentrating on stacking cash in the 1990s and 2000s on deflation fear, according to a source. In 1998, companies’ cash hoard was about a quarter of Japan’s GDP, whereas the current figure is about 70% of the country’s GDP. Since companies are sitting on cash piles, Japanese equities’ offer a quality exposure too.
Increase in Inflows in Japan ETFs
Investors also have faith in the Japan ETF as iShares MSCI Japan ETF (EWJ - Free Report) has amassed about $2.915 billion so far this year (as of Feb 19, 2018), as per xtf.com. This was against $8.08 billon outflows seen in SPDR S&P 500 ETF (SPY - Free Report) and $3.20 billion inflows seen in Vanguard S&P 500 ETF (VOO - Free Report) .
Any Threat Ahead?
A strong yen could prove to be a dampener in the wining story of Japan investing. Japan’s five-year economic recovery under Prime Minister Shinzo Abe revolved around a weak yen and the resultant gains in exports. So, a subdued yen is needed to push Japan stocks.
But CurrencyShares Japanese Yen ETF (FXY - Free Report) is up about 5.6% so far this year (as of Feb 16, 2018). If this trend continues, Japan investing will lose some of its steam as Japanese companies have huge overseas exposure and profits get lessened when repatriated back to the homeland.
Large-cap Japan ETF EWJ is up 2.2% so far this year while currency-hedged Japan ETF WisdomTree Japan Hedged Equity Fund (DXJ - Free Report) has lost about 3.6% and small-cap ETF iShares MSCI Japan Small-Cap ETF (SCJ - Free Report) with more a domestic focus has grown 0.6% in the year-to-date frame (as of Feb 16, 2018).
ETFs to Buy
Against the above-mentioned backdrop, it is wise to bet on non-hedged equity ETFs. Investors can thus play products like First Trust Japan AlphaDEX Fund (FJP - Free Report) , Goldman Sachs ActiveBeta Japan Equity ETF (GSJY - Free Report) , Deutsche X-trackers Japan JPX-Nikkei 400 Equity ETF (JPN - Free Report) , Franklin FTSE Japan ETF (FLJP - Free Report) and WisdomTree Japan SmallCap Dividend (DFJ - Free Report) .
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