Bank of Japan sticks to its policy, bullish for Japanese equities

Market Realist

No surprises from the Bank of Japan (of BofJ), but investors should look beyond the rhetoric

As expected, the Bank of Japan kept its “Abenomics” policy unchanged at its most recent meeting. The monetary base will continue to increase via purchases of Japanese Government Bonds (or JGBs) until the BoJ reaches its inflation target of 2%. Despite a massive amount of quantitative easing this past year, inflation is still only at 1% year-over-year. This implies that the BoJ will have to ramp up the printing presses even more in order to hit its target going forward.

(Read more: China’s wage inflation: Bad news for corporate profits and banks)

If the BoJ wants inflation, it will have to do more

The monetary base increased nearly 50% year-over-year in September, but this influx of yen has only been enough to pull Japan out of deflation. Japanese stocks have been the beneficiaries of “Abenomics” over the last year, as the yen has depreciated against other currencies. However, the recent strengthening of the yen is a signal that current monetary policy isn’t enough to reach the BoJ’s goal.

(Read more: Why China triggered harmful emerging market outflows)

The impending consumption tax hike is a headwind that the BoJ will have to adjust to

Even with combined fiscal stimulus, the planned tax hike is likely to negatively impact growth. The yen has been stuck around 100 per USD since April, and the inflationary effect of the BoJ’s policy could run off if the rate of asset purchases doesn’t increase. These two issues combined make increased quantitative easing likely in the beginning of 2014, which would be bullish for Japanese equities.

Investors should favor hedged equity exposure in light of possible increased easing

The WisdomTree Japan Hedged Equity Fund (DXJ) hedges yen exposure so investors are exposed only to Japanese equity performance. If the BoJ eases further, the yen will depreciate and stocks will rise. Some of this performance would be captured in unhedged funds such as the iShares MSCI Japan ETF (EWJ), but the currency conversion will eat into returns.

(Read more: Analysis: Why China’s export growth rates are slowing)

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Japanese monetary policy is important for investors in other global ETFs as well. Japanese equities comprise 21% of the iShares MSCI EAFE ETF, 21% of the Vanguard FTSE Developed Markets ETF (VEA), and 16% of the Vanguard FTSE All-World Ex-US Index Fund (VEU).

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