Since November, one of the most profitable trades in the markets has been long Japanese equities and short the Japanese yen. The reason is all about politics.
As you likely know, in December, the Japanese people voted for a change in economic policy when they elected Shinzo Abe as their new prime minister. The core premise of the Abe campaign was to reflate the massive Japanese economy via a devaluation of the yen. That devaluation is designed to make Japanese exports cheaper, and by extension, Japanese equities more valuable.
Well, that is precisely what happened.
The proof is in the numbers, as the Nikkei 225 soared almost 85% from Nov. 14 when the elections were announced through the most-recent high on May 23. As for the value of the yen, it sank precipitously. When compared to the value of the U.S. dollar, the yen lost nearly 30% over the same period.
In May, the Federal Reserve's talk of a potential tapering of quantitative easing sent most global markets lower, Japan included. The theory here is that if the Fed starts to taper, it could be the beginning of the end of the easy money policies fueling the markets.
Yet, over the past several weeks, it's become clear that even if we see the Fed begin to taper at its next FOMC meeting in September, that doesn't mean it is done priming the monetary pump. In fact, the new narrative set out by the Fed, and by other central bankers around the world, is that "tapering is not tightening."
In the case of Japan, there's no tapering in sight. In fact, according to Japanese political pollsters, the upcoming parliamentary elections in Japan will almost certainly ensure a continuation of what's now known the world over as "Abenomics."
Indeed, the polls are predicting a big victory for Abe's center-right Liberal Democratic Party (LDP) in the July 21 election. If this victory does in fact take place, then Abe's party will win back control of the upper house. The LDP already has control of the lower house.
The consolidation of power by Abe and the LDP in both houses of parliament will give the prime minister a clear mandate to move full throttle with his economic policy. For traders, that means there's still big upside in the long Japanese stocks/short yen trade. To take advantage of this, you can use two exchange-traded funds (ETFs).
WisdomTree Japan Hedged Equity Fund (DXJ)
This actively managed ETF invests in some of the largest Japanese companies, but it also is designed to hedge out currency risk. The fund recently spiked back above its 50-day moving average after the May-June sell-off. Now is the time to get long this fund in front of the parliamentary elections.
Recommended Trade Setup:
-- Buy DXJ at the market price
-- Set initial stop-loss at $44.40, approximately 8% below the current price
-- Set initial price target at $53.10 for a potential 10% gain in six weeks
ProShares UltraShort Yen (YCS)
This leveraged currency fund is designed to deliver performance results equal to twice the inverse of the U.S. dollar/Japanese yen trade. So, if the yen falls 2% versus the dollar, then YCS should move up 4%.
Recommended Trade Setup:
-- Buy YCS at the market price
-- Set initial stop-loss at $58.82, approximately 8% below the current price
-- Set initial price target at $70.32 for a potential 10% gain in six weeks
The narrative here is simple: More Abenomics means more upside for Japanese stocks and more downside for the yen, so position yourself accordingly.