In what has been one of the most popular (and crowded) trades over the past six months, the short yen, long Japanese equities has delivered significant returns for investors. The Bank of Japan or BOJ has, in conjunction with the rest of the government, embarked on a plan to end deflation in Japan. The plan, which many have named "Abenomics" after PM Shinzō Abe, is incorporating both expansionary fiscal and monetary policy. Japan is targeting a return to 2% annual inflation within two years, which is a tremendous feat for an economy that has been in a deflationary mode for so long.
Inflation Is Coming
Japan is undergoing significant quantitative easing, which has kept interest rates low, and should push Japanese investors out on the yield curve, as inflation expectations force money in from the sidelines. Abenomics is in a battle of psychology with the Japanese consumer. Many still are not sold on the idea that inflation is coming and that they must invest their assets to protect purchasing power as inflation returns to the country. As with any governmental or central bank's policy, economic effects of policy usually take a significant amount of time to be fully realized. As time goes by and inflation slowly creeps up to the 2% target, Japanese consumers and businesses will start to invest in Japan again. Additionally, the weak yen is a very important part of bringing inflation to Japan again. As the purchasing power of the yen decreases, imports become more expensive for consumers and businesses. After the Fukushima Daiichi nuclear meltdown in 2011, Japan shutdown the vast majority of its nuclear reactors, forcing the country to rely on oil and natural gas imports to generate electricity for the country. Since oil and natural gas are priced globally in dollars, Japan has to pay more yen for the same amount of oil or natural gas, assuming global prices stay constant. Energy prices will likely be one of the most important factors in bringing inflation to Japan again.
How To Play It
On January 9th of this year, I published an article titled, "2 Dividend-Paying Japanese Car Companies Set To Benefit From A Lower Yen" discussing two Japanese automakers that would benefit immensely from a weaker yen. This phenomena, however, is not just limited to the automakers. All Japanese exporters should benefit from a weakening yen, as they are able to undercut the competition in terms of foreign prices charged for their goods. This is possibly one of the most misunderstood portions of Abenomics, as it not widely discussed, but has very real potential to provide significant profits for Japanese firms and give them a significant competitive advantage. This could significantly boost the Nikkei as Japanese firms earn more profits. Some look to the iShares MSCI Japan ETF (NYSEARCA:EWJ) to play rising Japanese stocks. I am long the WisdomTree Japan Hedged Equity Fund (NYSEARCA:DXJ). The fund is long Japanese equities and hedges the position with a short yen position. I believe this a very effective way to play the Abenomics trade, and it takes advantage of both a lower yen and a higher Japanese stock market. The fund has experienced a significant amount of capital inflows recently, and is currently WisdomTree's largest ETF by AUM.
As Japan continues its very aggressive fiscal and monetary policies, the yen should continue to fall and Japanese stocks should benefit and continue to rise.
Disclosure: I am long DXJ. 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.