The horse latitudes of investment returns
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 as the currency weakened under new 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 they’ve seen in 2014.
The Bank of Japan: Further easing is still possible if consumption tax isn’t offset by wage gains and consumption growth
As we discussed in the prior article of this series, a lot 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 roll-out mode. As the above graph reflects, investors bought the roll out idea in 2012. Interestingly, Japanese investors were net sellers during this time, while the net buying came from foreign investors. This might suggest that the Japanese are sellers of Abenomics in general, and that the foreign investors were willing to take a speculative bite on Abenomics. It’s not hard to understand why the Japanese have been skeptical of “change they can count on.” Despite record profits in Japan—as in the USA—wage growth has gone nowhere (kind of like the bottom 60% of the USA). 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 U.S. GDP. Not too shabby if you’re in the top 5% of household net worth.
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: massive 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 800 billion yen versus 600 billion yen expectations. Importing energy is a real economic drag, and Japan doesn’t have the natural energy resources the U.S. does. While economists focus on the negative impact these issues could have on the Japanese economy near-term, they seem to be ignoring the effect Abenomics could 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 doesn’t look great, a weaker yen should support net corporate profits and the equity markets overall. The lower 60% might even get bigger paychecks.
To see the anticipated size of the Bank of Japan’s asset purchase program for 2014, please see the next article in this series.
For an overview of the U.S. macroeconomic recovery that could support Japan’s export economy, please see 2014 US macro outlook: The crack in the debt ceiling.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of the 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 could outperform both EWJ and other Asian equity indices, please see Why Japanese ETFs outperform Chinese and Korean ETFs on “Abenomics.” Plus, as Japan pursues unprecedented monetary expansion and the U.S. Fed tapers its bond purchases, Japanese equities could 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, please see Will the Fed take a bite out of Apple?