Yen Gain Seems Overdone; Time For Japan ETFs?

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Includes: DBJP, DFJ, DXJ, EWJ, FJP, FXY, HEWJ, JPXN, JSC, SCJ, UUP
by: Zacks Funds

It seems that the dark cloud hanging over Japan investing has started dispersing. After witnessing a tumult this year on a rising yen, Japanese shares have lately turned their course. The weakness in the Japanese currency, yen, was behind the recent surge in shares.

Two things made yen soggy. First, Japan indicated that it may intervene in the currency market to contain the strength in yen, which bothered exporters. Following this rhetoric, yen dropped about 3% from its 18-month high.

Second, the greenback is rallying and is now on its way to log the first monthly gain against the yen since January.

The greenback gained its lost ground on a flurry of upbeat economic data released lately, which in fact brought the Fed hike back on the table. The PowerShares DB USD Bull ETF (NYSEARCA:UUP) added about 1.7% in the last 10 days (as of May 17, 2016).

Overall, the greenback weakness and yen appreciation seem overdone and may fuel Japanese shares. Moreover, oil's ascent to a six-month high charged up energy shares. Notably, oil prices shored up on supply disruption in countries like Nigeria and a bullish call by the renowned brokerage house Goldman Sachs. If global markets remained relatively steady ahead on rising oil prices, yen may not gain strength on safe-haven demand.

How Important Are Yen Moves?

Investors should note that Japan's corporate profits (pretax) dropped 24% year over year in the March quarter and 40% sequentially, representing the worst quarter since the September quarter of 2012. However, it is not entirely because of yen as asset write-downs are incurred by Japanese companies in their final quarter of a fiscal year, as per analysts. Still, the impact of yen is huge as export-oriented automobile companies bore the brunt of a stronger yen, and recorded 472 billion yen in profit losses.

All in all, the government is wary of yen's strength and is likely to lower the value of yen if it spikes to the 90-95 per dollar range, as per a key economic adviser to Prime Minister Shinzo Abe. Moreover, nothing has yet been decided on a sales tax hike slated for next year.

Upbeat GDP Data

Meanwhile, the Japanese economy grew in Q1 at the quickest clip in a year, logging an annualized 1.7% growth rate against economists' expectations of a 0.2% rise. The latest growth was realized after a 1.7% revised annualized contraction in the fourth quarter of 2015, snapping the possibility of a technical recession.

Sequentially, the economy expanded 0.4% compared with a 0.1% quarterly gain. The best part is that domestic demand contribution to GDP grew 0.2 percentage points as consumers splurged on discretionary items. The data definitely explains that the economy is heading toward a positive direction.
Though weaknesses are there in the economy in the form of soft capex and consumer confidence data, things may improve in the coming days. Analysts indicated that a decline in capital expenditure was the result of weak exports. Japan exports capital goods to Asian economies and bears the brunt of a muted business environment worldwide, which hurts corporate profitability as well as the business investment.

Yen or GDP: What to Watch Ahead?

The first-quarter performance shows that stock moves in Japan are reliant mainly on yen, not on GDP. During Q1, yen gained about 7.23% against the U.S. dollar and the ultra-popular fund iShares MSCI Japan ETF (NYSEARCA:EWJ) - a guide to the Japanese stock market - responded to the yen strength by diving about 4.4% during this frame.

So, the prospect of no/less gains in yen can be a good entry point to Japan. Plus, a solid GDP reading can act as another tailwind. If yen spikes on upbeat GDP data, scope for currency intervention will likely open. The CurrencyShares Japanese Yen ETF (NYSEARCA:FXY) is up about 10% so far this year (as of May 17, 2016).

ETFs in Focus

Below, we highlight some Japan-focused ETFs that could be in watch in the coming days.

Regular ETFs

Among the regular ETFs, there are the First Trust Japan AlphaDEX ETF (NASDAQ:FJP) and the iShares JPX-Nikkei 400 ETF (NYSEARCA:JPXN). These are the bets to play in a falling dollar environment.

Currency-Hedged ETFs

These are, namely the WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ), the Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEARCA:DBJP) and the iShares Currency Hedged MSCI Japan ETF (NYSEARCA:HEWJ). If the yen falls and the greenback rises on possibilities of further Fed hikes, these currency-hedged ETFs may get a boost.

Small-Cap ETFs

There are also options - the iShares MSCI Japan Small-Cap ETF (NYSEARCA:SCJ), the SPDR Russell/Nomura Small Cap Japan ETF (NYSEARCA:JSC) and the WisdomTree Japan SmallCap Dividend ETF (NYSEARCA:DFJ) - to bet on Japanese domestic demand.

Since small-cap companies are less exposed to the international economies, investors can wipe out the impact of yen as well as the struggling export sector by investing in these ETFs.

Notably, SCJ (up 1.5%) has outperformed EWJ (down 4.2%) and DXJ (down 14.8%) in the year-to-date frame (as of May 17, 2016).

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