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Japan’s Stock Market Crushes Others in 4Q – Here’s How to Sidestep Currency Nastiness

That rumble you hear from the Far East appears to be the Japanese stock market waking up from an interminable hibernation. After going literally nowhere for more than a decade, Japan’s stock market is up more than 14% (in local currency) in the fourth quarter according to MSCI. That’s the strongest performance among the major developed economies. The U.S. market is down 1% for the quarter to date, the U.K. is up 3.7%, Canada is up 1% and Germany is up 6.1%.

Japan is even standing tall among the faster-growing emerging markets. That 14% advance is ahead of the 11.5% gain in China, Brazil’s 4.7% rise in the fourth quarter, India’s 3.5% gain and the 1% pickup for the Russian stock market.

The only hotter markets in the fourth quarter were the much smaller satellite economies of Greece (up 25%) Turkey (up 16.6%) and Austria (up 15.7%).

As explained in this YCharts post on Japanese stocks, the election of a new political party with a mandate to push through aggressive economic reform is behind the stock market rally. And there’s plenty more room to go in this value play. Major Japanese stock indexes currently trade below book value. The large cap stocks listed on the Tokyo Stock exchange trade at an average of 0.80 of book value. By comparison, the S&P 500 is currently trading at about 2.2x book value.

The one big caveat to this intriguing shift is that simply going long the Japan stock market isn’t going to work. One of the major pieces of the economic platform for the Liberal Democrat party is to push down the value of the yen against major currencies. That’s already looking to be in play:

US Dollar to Japanese Yen Exchange Rate Chart

US Dollar to Japanese Yen Exchange Rate data by YCharts

A weaker yen against the dollar is going to help Japanese manufacturers on the export front. But for U.S. investors, it eats into returns. The 14% gain for the Japanese stock market in the fourth quarter in local currency becomes less than 5% when converted to U.S. dollars.

That’s an argument for hedging any stock investment. As its name makes clear, the WisdomTree Japan Hedged ETF (DXJ) is hedged. The iShares MSCI Japan ETF (EWJ) isn’t.

EWJ Chart

EWJ data by YCharts

Or if you want to invest directly in some export-driven Japanese manufacturers, you can build your own hedge by shorting the CurrencyShares Japanese Yen ETF (FXY) or adding an inverse ETF such as the ProShares UltraShort Yen ETF (YCS).

FXY Chart

FXY data by YCharts

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.

Read more articles about: Investing Ideas  

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