Will the growing Toyota profits boost Japanese ETFs this year?

Market Realist

For GM, which is worse—the recall or a weakening yen? (Part 12 of 12)

(Continued from Part 11)

A flat past year for Japan flat

The below graph reflects the performance of Asian equity ETFs since the election of Japan’s new Prime Minister in November 2012. The Japanese ETFs—DXJ and EWJ—performed very well in 2013 as the Japanese yen weakened under new fiscal and monetary policy initiatives. Meanwhile, both Korean and Chinese ETFs—EWY and FXI—have been flat, with China still in slightly negative territory. This article considers the prospects for these main Asian ETFs to break out of the doldrums in 2014, as Japan’s automakers such as Toyota Motors (TM) and other exporters benefit from a weakening yen.

For more detailed analysis of the overall Japanese economy, read Bank of Japan Tankan supports a 2014 equity rally in Japan.

Bank of Japan—further easing is still possible, if consumption tax is not offset by wage gains

Much is on hold in Japan right now. Major initiatives have just been put into place and will roll out over 2014. Simply put, Japan is very much in rollout mode. As the above graph reflects, investors bought the roll out idea in 2012 and have been marking time since June last year. Interestingly, the Japanese investors were net sellers during the market rally, while the net buying came from foreign investors. This might suggest that the Japanese are sellers of Abenomics, and that the foreign investors were willing to take a speculative bite on Abenomics. It is not hard to understand why the Japanese have been skeptical of change they can count on. Despite high corporate profits in Japan—as in the U.S.—wage growth has gone nowhere in Japan. The wealth effect from a Nikkei at 15,000 is almost nothing, while the U.S. rally has seen household net worth hit records—$80 trillion, or about 500% of the U.S. GDP.

The U.S. bull market, Asian doldrums, and Japan’s potential edge

Despite the baked-in skepticism at home, the Abenomics wild card remains in play: large fiscal deficits and massive quantitative easing will continue in 2014. Japan has been running a trade deficit for 20 months now—with February data coming in at an 800 billion yen deficit versus 600 billion yen deficit expectations. While economists focus on the negative impact this can have on the Japanese economy near term, they seem to be ignoring the effect this can have in the longer term, if the Japanese yen weakens. In the long run, Japan needs a weaker yen. If the trade deficit drags too much on growth in 2014, the Bank of Japan seems poised to facilitate. Should we go into the third quarter with soft GDP data, keep an eye open for more bombshell measures from the Bank of Japan toward the end of the year. Even if GDP data does not look great, a weaker yen should support net corporate profits and the equity markets overall. With this background, Japanese automakers were able to raise wages in 2014. Perhaps this virtuous cycle of a weak yen and wage growth will support further recovery in Japan, along with the stock price of Toyota, leading to renewed momentum in Japanese ETF’s, DXJ and EWJ.

Japan’s equity outlook

As 2014 progresses, investors may see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). For further clarification as to why DXJ may outperform both EWJ and the other Asian equity indices, read Why Japanese ETF’s outperform Chinese and Korean ETF’s on Abenomics. Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities can also outperform broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).

For more on how the U.S. Fed’s recent announcements could impact global equities, read Will the Fed take a bite out of Apple?

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