The critical Bank of Japan meeting that market participants are waiting for begins April 3 and concludes the next day. This will be the first meeting with Haruhiko Kuroda as the new head of the BOJ. Markets have built in lofty expectations for this meeting and traders are nervous that the BOJ may disappoint. This is the reason why the yen has strengthened recently against the US dollar from just shy of 97 to under 93 today.
Investors need to keep in perspective that Japanese stocks right now are a currency play. The direction of the Nikkei 225 is driven by what the yen is doing in the forex market. If the yen weakens, Japanese stocks strengthen and vice versa.
Since September the yen has weakened from 77.195 to 96.705 in March against the US dollar. This is an extraordinary strong move in the forex market and the market has definitely changed from a bear trend to a bull trend. The move behind this was the rhetoric from new Prime Minister Shinzo Abe and his vow to end deflation in Japan and spur a Japanese economic revival.
To understand this properly, you must first understand what deflation is. Deflation occurs when the inflation rate falls below 0% or negative inflation. Japan has experienced deflation since the 1990s. Do you not think the past governments didn't try to end deflation? Former BOJ Governor Misaaki Shirokawa said as he left office that ending deflation in Japan will be no quick fix. He said, "if there was a single thing that would have cleared the fog and solved all the problems, Japan wouldn't have been in this situation for 15 years".
Haruhiko Kuroda for his part does say that the BOJ does have some tools that can help the Bank reach its stated goal of 2% inflation. For one they can buy more debt with longer-dated maturities. But in the end it must trickle down to the average Japanese. If businesses remain pessimistic, they won't invest or raise wages. To achieve the Bank of Japan's inflation goals, businesses must spend and invest in the economy. Until they do that, the Bank of Japan can only do so much.
Bullish on Japanese Stocks
With all this being said, I am still bullish on Japanese equities. There's been a trend change in the Japanese yen that has yet to flow to the corporate bottom-line. Most major Japanese corporations were not fully prepared for the dramatic weakening in the yen and still have currency hedges on. The weaker yen is a gift to Japanese exporters.
Since the beginning of the year, the Nikkei 225 is up 15.96%. The Index reached a high last month of 12,650.26 and is currently trading just above 12,000. Traders have locked in some of their profits, but the smart money is buying the dip.
WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ)
Dividend Yield: 1.35%
The best way to play the overall Japanese market is with the WisdomTree Japan Hedged Equity ETF . Since February 27th it's up 11.01% versus iShares MSCI Japan Index ETF (NYSEARCA:EWJ) which is only up 4.72% over the same time period. The WisdomTree ETF provides exposure to the Japanese equity market while at the same time neutralizing fluctuations in the yen. The top 10 holdings for the ETF are Mitsubishi UFJ Financial (NYSE:MTU), Takeda Pharmaceutical (OTCPK:TKPHF), Canon (NYSE:CAJ), Honda Motor (NYSE:HMC), Mitsui (OTCPK:MITSY), Japan Tobacco (OTCPK:JAPAF), Nissan Motor (OTCPK:NSANY), Toyota Motor Corp (NYSE:TM), Astellas Pharma (OTCPK:ALPMY), and Itochu Corp.
Toyota Motor Corporation
Dividend Yield: 1.30%
Toyota is the world's top-selling car marker. The company has the over the years transitioned a large portion of its manufacturing to Thailand. Thailand offers cheap wages and great ports for export.
From a valuation standpoint, Toyota is very attractive. The company has a forward P/E of 13.16 and a PEG ratio of only 0.40. Toyota's return on equity is 7.94% and has a book value per share of $90.38, just shy of its $101 trading price. The annual dividend is $1.36 per share.
Dividend Yield: 4.20%
Canon is one of the world's leading producers of plain paper copying machines, laser printers, inkjet printers, lithography equipment, and of course, cameras. Whereas the Koreans and Chinese have been able to build national competitors to many Japanese companies, they haven't been able to develop a camera to take on Canon or Nikon. In Asia I still see the Chinese or Korean tourists with only a Canon or Nikon camera.
From a valuation perspective, Canon has a forward P/E of 14.36 and an operating margin of 9.31%. The annual dividend is $1.52 for a yield of 4.20%. The company has only $50 million in debt versus a total cash position of $8.83 billion. The book value per share is $28.64 and the company is trading just below $36 per share.
Mizuho Financial Group, Inc. (NYSE:MFG)
Mizuho Financial Group is an international Japanese bank. The name means "abundant rice" or "harvest". With its operating subsidiaries the company controls over $2 trillion in assets. The company is the second largest financial services group in Japan.
Mizuho has a forward P/E of 11.91 and has a return on equity of 10.19%. The stock is trading below its book value per share of $5.47. Over the last year the stock is up over 27%.
BOJ Meeting Outlook
This week's BOJ meeting will be the first headed by new Governor Haruhiko Kuroda. The market has high expectations for this meeting. Traders are looking for significant action and not just "verbal communication." There is the potential for traders to be disappointed and for the yen to strengthen. If that happens, look for Japanese stocks to sell off. If the market does sell off, I would use that as an opportunity to buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.