Exchange traded funds tracking Japan, the world's third-largest economy, have done something many U.S.-focused ETFs did not do: Perform well immediately following a national election. While it was not surprising to see Shinzo Abe reclaim the role of prime minister (he resigned the post in 2007 citing health reasons) and his Liberal Democratic Party sweep to a majority in Japan's lower house of parliament, Japanese equities have surged to the upside in the wake of the election results.
The election results were known on Sunday, December 16. Since Monday, December 17, the iShares MSCI Japan Index Fund (EWJ) has added 1.2 percent while the WisdomTree Japan Hedged Equity Fund (DXJ) has jumped 2.4 percent.
Rallying Japanese equities is no doubt the result of Abe's campaign rhetoric, which centered around weakening the yen. Abe called on the Bank of Japan to engage in "unlimited monetary" easing to depress Japan's currency in a bid to help the nation's exporters. The central bank kicked off a two-day meeting today and action is expected as Abe has pledged to pressure the bank to immediately weaken the yen.
"Most of all, he has stressed his intention to hold the BOJ accountable to these goals, threatening to remove the central bank's independence if it fails to act," said WisdomTree Research Director Jeremy Schwartz in a note.
Schwartz that notes no one knows exactly what Abe's targets are for the yen, but the issue may not be as much about specific levels as it is about psychology.
"No one knows what target level Abe has for the yen, but if he can produce a psychological shift in the prospects for the currency, I believe that there could be major moves over the next few years," said Schwartz. "As a baseline, from the December 17, 2012 level of approximately 84 yen to the U.S. dollar, a 50% depreciation of the yen relative to the dollar would bring the value of the yen close to the 120-yen-per-dollar level seen around June 16, 2006. I am not expecting that to happen in the immediate future, but it provides a sense of how significant the yen's performance relative to the U.S. dollar has been over this period."
Both equity and forex traders have shown they expect the yen to weaken. In addition to the aforementioned impressive performances by DXJ and EWJ, the ProShares UltraShort Yen (YCS) has gained 2.2 percent this week.
Still, Abe has his work cut out for him in terms of weakening the yen. The CurrencyShares Japanese Yen Trust (FXY) turns six in February and over that ETF's life, it has returned 38.4 percent, indicating the yen has been in a long-term uptrend.
The yen's multi-year rise shines the light on opportunities with the WisdomTree Japan Hedged Equity Fund. As was recently noted, December marks the first month that DXJ's index will trade with a geographic filter to remove companies that derive the bulk of their revenue from Japan.
The notion of hedged yen exposure has proven more than viable as DXJ has gained 14.7 percent year-to-date while EWJ has added just 5.7 percent. Noteworthy is the fact that investors are buying into what DXJ has to offer. As of mid-November, the ETF had $516 million in assets under management. That number surged to $648 million as of early December, but it now rests at $845.2 million, according to WisdomTree data. DXJ's asset growth could be a sign that investors are finally buying into the "Japanese equities are cheap" theme, but are doing so while avoiding yen-related risks.
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