The news of Japan’s economy contracting for the second consecutive quarter came as a surprise to economists who predicted an expansion following boosted quantitative easing efforts. The increase in sales tax this year to spur inflation was enough to sink the world’s third-largest economy into a recessionary environment after a 1.6 percent drop in gross domestic product this quarter.
Recent announcements from Prime Minister Shinzo Abe have helped boost stock prices in Japan over the last several months. However, their government-sponsored stimulus has not proven to have significant staying power to reverse years of deflationary effects.
The iShares MSCI Japan ETF EWJ is the largest single country ETF that tracks over 300 stocks in the land of the rising sun. After a strong showing in October, this index has fallen 4 percent in November and looks ready to break back below its long-term moving averages.
EWJ is now back in negative territory for the year and may struggle amid further headline risk to close out 2014 on a positive note.
A leading indicator of concern has been plunging currency prices that have been driven by exponential quantitative easing programs in Japan.
The Guggenheim CurrencyShares Japanese FXY is an ETF designed to track the daily price movement of the yen versus the U.S. dollar.
Since hitting a high near the mid-point of 2014, FXY has been in a steep decline that has been fueled by investors moving to safer dollar-denominated assets. At one point, a lower yen was seen as bullish for the Japanese stocks that make up EWJ. However, that correlation has deteriorated recently as conditions have proven deflationary in both asset classes.
One ETF that has benefited from the recent depreciation in the yen is the WisdomTree Japan Hedged Equity Fund DXJ. This fund combines a basket of long equity securities in Japan with short yen exposure. The combination has produced positive gains of nearly 6 percent this year.
Investors with significant overseas exposure to developed markets should pay close attention to the recent developments in these Japan ETFs. Further deflation in this economy may impact the Asia region and other trade partners as well.
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