Over the past few months I have read countless articles about the Wisdom Tree Japanese Hedged Equity, also known as DXJ. I stumbled in to this ETF a while back after reading about the efforts of the Bank of Japan to curb the chronic deflationary issues of the Japanese economy. Before seeking out a way to capitalize, I chose to look a little bit deeper into the economics of the situation. I accessed some useful charts on tradingeconomics.com to look at the inflation/deflation situation as well as the growth in the money supply, growth in GDP, and Japan's trade account. These charts will give you great insight into the issues that Japan has faced for years. (click to enlarge)(click to enlarge)(click to enlarge)(click to enlarge)To put it simply, deflation occurs when the growth rate in Real GDP begins to exceed the growth rate in the money supply. This has the effect of lowering the price level in the economy and strengthening the currency with respect to other currencies around the world. The new found currency issue decreases the cost of imports and makes the country's exports more expensive for other countries. This issue becomes a drag on the nation's economy when it manifests itself in trade deficits. The indicators that I previously mentioned all work in unison to create the burden on Japan's economy. Regardless whether or not the Bank of Japan is at least partially responsible for the country's deflation issue, (I believe it is) the bank's goal now is to create inflation. I may be skeptical of the central banks most of the time, however, when they start publicly stating inflation targets and even stock market targets, I take note. Now to the fun part...
DXJ has been promoted almost relentlessly in recent months. I was shocked when I received a DXJ market current on my phone from Seeking Alpha stating that the Economy and Finance minister Akira Amari set a target for the Nikkei index. The target set was 13,000 by the end of March and at the time the Nikkei was right around 11,370. As an owner of DXJ I was curious what my holding would look like if the target was reached. I compiled data ranging from 2006-present comparing weekly closing prices of DXJ and the Nikkei index. I used regression analysis to create a model that would accurately forecast the share value by the time the Nikkei reached 13,000. The formula:
DXJ = 11.8869 + (0.0026 * Nikkei)
The formula suggests that DXJ would be $45.69 per share if the Nikkei reached 13,000. It is also important to note that the correlation coefficient of the two sets of data is 0.96. This is compelling. Fast forward to today (March 11), and plug in the Nikkei value. You get a DXJ share price of $43.99. The actual closing price was $43.48. I tested the last 5 days of trading and found that the model overshoots the actual close by an average of about 52 cents. With that being said, and with the Nikkei at 12,349.05, I believe DXJ will hit roughly $45.17 per share by the time the Japanese stock market target is reached. That's roughly a 4% increase from where we are today.
I believe DXJ is the proper equity play for Japan given the circumstances. The ETF is up almost 29% over the last three months. This movement has been facilitated by strong rhetoric coming from the central bank and the promise to prop up asset prices. Given the strong movement of the fund over recent months, I do not believe that it is too late to buy. Loose monetary policy will continue in Japan, at least in the near term, and this will keep Japanese equities on the up and up.
The chart below says it all. I would encourage you all to put the regression equation to use, especially if the BOJ comes out with any new Nikkei targets for next month. As I said before, I would deduct about 0.50 from the predicted DXJ prices. This should give you an even more accurate reading. Enjoy the ride!
Disclosure: I am long DXJ.