Japan’s benchmark stock index Nikkei soared to a 21-year high owing to positive economic data, relatively low valuations, strong earnings and improved sentiment in the United States. The index increased 0.3% to its highest close since December 1996.

This is expected to boost prime minister Shinzo Abe’s confidence as he is campaigning to convince voters that the Japanese economy is on a healthy track before the Oct 22 snap elections. Moreover, investors are expecting Abe to win, which in turn has been a positive for the markets (read: Time to Buy Japan ETFs as Recovery Gains Momentum?).

Economic Data

Japan’s economy grew an annualized 2.5% in the second quarter compared with preliminary estimates of a 4% expansion (read: Japan's Q2 GDP Revised Down: ETFs in Focus).

The International Monetary Fund upgraded its forecast for Japan’s growth rate to 1.5% in 2017 compared with its July forecast of 1.3% expansion as exports gain momentum.

The BOJ released its quarterly survey of over 10,000 businesses, which showed that business confidence among large manufacturers improved to a 10-year high of plus 22 in September from plus 17 in June. A positive reading implies more manufacturers find conditions to be favorable than unfavorable.

Moreover, industrial production increased 2.1% in August on a monthly basis, above a Reuters forecast of 1.9%, while household spending increased 0.6% year over year in August.

Wall Street Impact

Global economic recovery and strong profits have led to a rally in markets around the world. Japanese companies have been performing well on stronger exports, especially the automobile sector as the United States recovers from the impact of hurricanes Harvey and Irma and car sales increased. Moreover, per a Bloomberg article, foreign investors poured 201.8 billion yen ($1.8 billion) into Japanese equities during the last week of September as investors grow more optimistic about the Japanese economy’s future.

The U.S. economy registered strong growth of 3.1% in the second quarter. Rate hike proponents argue that the U.S. economy is on solid ground and can sustain further rate hikes.

Although the markets still expect a rate hike in December, the latest Fed minutes have done little to assure investors of one. The argument over whether another rate hike can be supported amid still-low inflation continues, with policymakers unable to reach a consensus.

Despite many Fed officials agreeing on a rate hike in December, some argued that their decision will depend on inflation inching toward their 2% target in the coming months. Although the greenback declined, the broad consensus in the markets is in favor of a rate hike in December. A stronger dollar is a positive for Japanese companies as it boosts their export sales.

Risks Involved

Japan is also subject to geopolitical risks as Asian markets suffer from massive volatility due to North Korea’s actions. Per the latest report by a Russian news agency, the RIA, a Russian lawmaker’s recent visit to Pyongyang has revealed that North Koreans are prepping another long-range missile test that has the capability to reach the west coast of the United States. Moreover, North Korea’s foreign minister Ri Yong Ho suggested that another hydrogen bomb test in the Pacific Ocean might be in the cards.

Increased geopolitical uncertainty and relative lack of consensus regarding a rate hike by the Fed make us look for currency-hedged ETFs focused on providing exposure to Japan (see Asia-Pacific (Developed) ETFs here).

WisdomTree Japan Hedged Equity Fund (DXJ Quick QuoteDXJ - Free Report)

This fund is suitable for investors looking for a broad-based exposure to the Japanese economy. It seeks to invest in dividend-paying companies with an export tilt.

The fund has AUM of $8.3 billion and charges a fee of 48 basis points a year. From a sector look, Consumer Discretionary, Industrials and Information Technology are the top three allocations of the fund, with 25.4%, 22.0% and 13.6% exposure, respectively (as of Oct 11, 2017). Toyota Motor Corp, Mitsubishi UFJ Financial Group and Japan Tobacco Inc are the top three holdings of the fund, with 5.5%, 3.6% and 3.4% exposure, respectively (as of Oct 11, 2017). It has returned 11.7% year to date and 26.6% in a year (as of Oct 11, 2017).

Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP Quick QuoteDBJP - Free Report)

This fund seeks to provide exposure to Japanese equities with a large-cap focus, while hedging away the currency risk.

The fund has AUM of $1.6 billion and charges a fee of 45 basis points a year. From a sector look, Industrials, Consumer Discretionary and Technology are the top three allocations of the fund, with 20%, 19% and 14% exposure, respectively. Toyota Motor Corp, Mitsubishi UFJ Financial Group and Softbank Group Corp are the top three holdings of the fund, with 4.7%, 2.3% and 2.0% exposure, respectively (as of Oct 10, 2017). It has returned 10.5% year to date and 24.0% in a year (as of Oct 11, 2017).

iShares Currency Hedged MSCI Japan ETF (HEWJ Quick QuoteHEWJ - Free Report)

This fund is the currency-hedged equivalent of EWJ. It seeks to provide exposure to Japanese equities with a large-cap focus, while hedging away the fluctuations between the USD and JPY.

The fund has AUM of $1.2 billion and charges a fee of 49 basis points a year. From a sector look, Industrials, Consumer Discretionary and Information Technology are the top three allocations of the fund, with 20.6%, 20.3% and 12.8% exposure, respectively (as of Oct 10, 2017). Toyota Motor Corp, Mitsubishi UFJ Financial Group and Softbank Group Corp are the top three holdings of EWJ, with 4.8%, 2.3% and 2.0% exposure, respectively (as of Oct 10, 2017). It has returned 12.4% year to date and 25.1% in a year (as of Oct 11, 2017).

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