The Nikkei Hits New High – Here's How to Play the Rally

It’s a story as old and sadly, as ordinary as the U.S. equity market performance of late and equally as sad-or interesting-or mundane-or expected, is that it’s happening for the same reasons.

Reuters is reporting that the Nikkei, the stock market index for the Tokyo Stock Exchange, hit a five and a half year high again today. The index was up 222.69 points to close at 15,360.81—its highest close since December 27, 2007.

The Nikkei is up 48 percent this year alone and eight percent since May 9 after the dollar rose above the key 100-yen level.

But the reason for such a move is all-too-familiar to U.S. investors. It’s all about quantitative easing. Japanese Prime Minister Shinzo Abe instituted QE on a scale that makes the U.S. QE look insignificant. At $1.4 trillion, Japanese QE is 60 percent larger than in the United States.

Japan’s QE is Abe’s answer to a country that had seen a period of deflation following catastrophic economic events over the last decade. Those included a stock and property bubble that resulted in a severe plunge much like that of the United States in 2007 and a massive earthquake that led to Tsunami and a nuclear meltdown that saw the country turn its back on nuclear power.

QE is doing to Japan what it has done in the United States. Markets are soaring despite less-than amazing economic data but investors are cautiously pouring money into the market knowing that it’s largely dependent on the liquidity program continuing.

But there is a difference between the U.S. and Japanese programs. Koichi Hamada, one of Abe’s chief advisors said that although the government endorses the devaluation of the Japanese currency, they’ll likely put a stop to it if it goes too far. According to Bloomberg, if the yen reaches the 110 level against the dollar, that might be the point where Japan puts the breaks on the rally.

In the United States, investors are largely in the dark. This week, they will listen to Fed Chairman Ben Bernanke’s remarks to see if any mention of a QE drawn down is in the Fed’s plans.

Unlike the U.S. liquidity program, Japan’s QE is likely only in the beginning stages. Even if the weakening yen makes Japanese officials nervous, the rally might be slowed but won’t end. Investors who have held the WisdomTree Japan Hedged Equity Fund DXJ have seen a gain of 58 percent in the past six months.

Other ways to play the move is through Japanese ADRs like Toyota Motor TM, Honda Motor HON, and Sony SNE.

The rise of both the U.S. and Japanese equity markets is becoming ordinary but that doesn’t mean that investors should put their full faith in either rally. Both markets are due for a correction with quality entry points getting more difficult to find.

Disclosure: At the time of this writing, Tim Parker was long the WisdomTree Japan Hedged Equity Fund and doesn’t plan to sell it any time soon.