Japanese Stocks, Up 30% YTD, Headed Higher? ETF Protects Again Falling Yen

Japan’s election of a new government last December -- one that campaigned on a promise to tackle the entrenched economic deadweights of a strong yen and deflation -- triggered a strong stock rally through March, as seen in a stock chart.

^N225 Chart

^N225 data by YCharts

Turns out the strong first quarter for the Nikkei was just the opening act. On April 4th, the Bank of Japan’s new governor unleashed the mother of all monetary interventions: A plan to nearly double Japan’s monetary base by the end of 2014 through projected BOJ purchases valued at U.S. $1.4 trillion. In the ensuing week the Nikkei rose another 5.2%.

Despite the strong rally, some smart pros aren’t looking for the exit. The management team at Oakmark International fund wrote in its first-quarter note that it saw no reason to sell Daiwa Securities even though the stock price had doubled in the past six months. Same goes for its Olympus stake, which rose 22% in the quarter. To be clear: Oakmark is a deep, deep value stock shop with a phenomenal track record. If they’re sticking with Japan, that tells you something.

Doubleline’s Jeffrey Gundlach, who grabbed headlines late last year with his short-the-yen/go-long-Japanese-stocks trade is still sticking with that on-the-money call, despite some backup in the yen (after an epic fall from last Dec) in the days leading up to the BOJ announcement. (It’s falling again.) Gundlach has repeatedly stated he thinks that over time the Japanese yen could sink all the way to 200 against the US dollar. We’re not even at 100 yet.

US Dollar to Japanese Yen Exchange Rate Chart

US Dollar to Japanese Yen Exchange Rate data by YCharts

For the shorters out there, there’s the CurrencyShares Japanese Yen Trust ETF (FXY) which is down more than 20% over the past six months.

For stock investors, if Gundlach is right with that call, the WisdomTree Japan Hedged ETF (DXJ) is going to be a major benefactor. Over the past six months as the yen weakened more than 20% against the dollar the hedged approach crushed the performance of the unhedged iShares MSCI Japan ETF (EWJ).

DXJ Chart

DXJ data by YCharts

No surprise, exchange traded funds that invest solely in Japanese equities are already getting plenty of attention. There was a net inflow of $5.4 billion in the first quarter, according to Morningstar. That represents about 40% of the $13 billion total asset base of the Japan ETFs.

The WisdomTree Japan Hedged ETF was the primary beneficiary. It took in $3.9 billion in the first quarter according to Morningstar, bringing its total assets to $5.6 billion. A year ago assets sat at $600 million. (WisdomTree has filed plans to launch a Japan Hedged SmallCap Equity ETF. it already runs an un-hedged Japan Small Cap ETF (DFJ) which gained more than 16% in the first quarter.)

The WisdomTree portfolio is designed to focus on companies that derive plenty of revenue from exports; a falling yen makes Japanese goods more competitive in the global marketplace. The ETF’s top five holdings currently are Takeda Pharmaceutical, Mitsubishi UFJ Financial Group (MTU), Canon (CAJ), Honda Motor (HMC) and Japan Tobacco.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

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