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This 'No-Brainer' Fund Is Still The Best Yen Play

Karen Canella

Shorting the yen and going long Japanese stocks have basically been no-brainer investments for the past couple of years. That's especially true when you consider there's an exchange-traded fund (ETF) that accomplishes both: the WisdomTree Japan Hedged Equity Fund (NYSE: DXJ)

DXJ has gained 48% over the past two years and 25% this year, but it's been flat or slightly negative for the past six months. One reason DXJ has slowed is that talk of a U.S. government shutdown sent investors to the yen as a safe haven, pushing it higher. 

I suspect now that all is quiet on that front that the yen will continue its downward trend.

Still, there's speculation that this trade may be dead.

It all boils down to whether Japanese Prime Minister Shinzo Abe sticks to his loose monetary policy, aka Abenomics, which has been in place since he took office in December 2012. Abe vowed to kick-start Japan's stagnant economy by deploying a bond-buying program of 7.5 trillion yen ($75 billion) a month, much like the U.S. is doing.

The strategy was designed to reflate the world's third-largest economy by devaluing the yen. In turn, that devaluation would make Japanese exports cheaper and equities more valuable.

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The Nikkei 225 soared almost 85% from Nov. 14, the day election results were announced last year, through its high on May 23. The yen lost nearly 30% of its value against the U.S. dollar over the same period.

It seemed like the stimulus might actually be working in May and June when the yield on 10-year Japanese government bonds rose from 0.4% to nearly 1% in less than two months. However, the 10-year yield has come down to 0.6% today, the lowest in five months, and some Japanese analysts suggest rates may fall as low as 0.25%. 

So Japan's economy continues to sputter. 

The monetary injections have had literally no effect on the country's debt, which has skyrocketed to over 230% of its GDP today from about 60% in 1990. On the contrary, if Abe continues to purchase that many government bonds every month, the ratio could reach 240% in 2014. 

  Flickr/Secretary of Defense  
  After taking office last December, Prime Minister ​​Shinzo Abe vowed to kick-start Japan's economy by deploying a bond-buying program of 7.5 trillion yen ($75 billion) a month.  

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That is likely to happen considering the Bank of Japan recently upped the ante, calling for "unlimited easing": monthly purchases of 10 trillion yen in Treasury notes and 3 trillion yen in Japanese government bonds, beginning in January 2014. 

To put Japan's upside down economy in perspective, its quadrillion-yen debt is equivalent to $10 trillion, compared with the United States' nearly $17 trillion. However, because its GDP is one-third as large as that of the U.S., Japan's debt-to-GDP ratio is nearly double that of the U.S. 

On top of debt, Japan's trade deficit in September hit 932 billion yen ($9.5 billion), its 15th consecutive monthly imbalance. A 5 trillion-yen deficit for the first half of the fiscal year set a record.

All these statistics paint a rather dismal picture, but Japan's Cabinet Office said its monthly economic report released last week showed that the country "is on the way to recovery at a moderate pace." Yet exports slowed for the second straight month due to weakening demand in China and other Asian countries. 

Fiscal policy minister Akira Amari also said, "There seems to be a pause in personal spending, corporate profits and sentiment, but recent price developments indicate that deflation is ending."

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Translation: There's no end in sight to the tapering, and for an economic recovery to take root in Japan, the yen must weaken even further.

That means investors can expect this year's top asset-gathering ETF to resume its upward trend along with a couple other investments designed to deliver profits from a weak yen and strong equities.

• You can short the CurrencyShares Japanese Yen Trust ETF (NYSE: FXY) or, if you trade options and you don't want to go short, you can buy puts on FXY. FXY has lost about 12% this year.

• There's also a way to go long Japan stocks via ETFs. The iShares MSCI Japan Index Fund (NYSE: EWJ) is the most common, with assets of more than $5 billion. The EWJ fund is up about 23% this year. Its top holdings include Toyota, Mitsubishi Financial, Honda, Japan Tobacco and Canon. 

Risks to Consider: In the short term, there may be knee-jerk investor reactions to positive economic news that could send the yen temporarily higher -- or, in the case of the 7.3-magnitude earthquake and subsequent tsunami warnings that shook Japan last week, to negative news that could take equities lower. I don't see anything substantial enough on the horizon to shift either trend long term, however.

Action to Take --> I really like the DXJ for profiting from the weak yen and strong equities. The fact that it has remained flat over the past six months provides an opportunity to buy at a lower price ahead of its next leg.

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