Positioning for Japan’s Upcoming Stimulus Package

Japan is back. After being practically the worst-performing equity market in the developed world in the first half of 2016 on the back of a strengthening yen, Japan has rallied strongly from its post-Brexit bottom in anticipation of a large, creative fiscal package. Anticipation of this Japanese macro event has grown, and many also believe the central Bank of Japan (BOJ) may finance the bonds the government issues with expanded monetary stimulus. See the charts below for the performance of our currency-hedged Japan strategies through the first half of 2016 and in the first three weeks of July. Clearly Japan is back on track in its July performance, but will it stay there?   Fund Performance from YTD 2016 to June 30,2016   Fund Performance from July 1, 2016, to July 21,2016 For current performance of WisdomTree exchange-traded funds (ETFs), click here.   What Is the Expected Timing of Japan’s Stimulus? Going into this week, we believed the coordinated activities of the fiscal stimulus, followed by the central bank expanding its bond-buying program to effectively buy the additional bonds created by the supplementary fiscal package, will occur in the August-to-September period. However, in a surprise announcement on Wednesday in Tokyo, Prime Minister Shinzo Abe unveiled a 28 trillion yen fiscal package ($265 billion), the final details of which will be approved at a cabinet meeting next week. Our Japan team felt strongly that Team Abe would be both creative and coordinated – and that the Bank of Japan would not announce additional stimulus until the fiscal package was released. Now that Abe has accelerated the announcement of the size of his fiscal package, we also believe the BOJ raising its monetary stimulus package – to effectively finance the additional deficit created by the stimulus-- is now likely to occur this week as well. [Updated on 7-29: Our original expectation on timing proved correct. While the BOJ doubled their equity purchases through ETFs from 3 trillion per year to 6 trillion per year at the July meeting, Governor Kuroda hinted it was too early to coordinate with the government on the fiscal side, despite Abe’s announcement. This additional BOJ support from expanded bond purchases is now expect to occur at the September meeting]. Jesper Koll, WisdomTree's Japan CEO, has outlined a case for a structurally weak yen going forward. Given the yen’s appreciation in 2016 and the decline in equities—on factors that we would say were more Federal Reserve (Fed) policy-related and less related to the fundamentals of Japan’s economic situation or interest rate policies—there are now opportunities to re-engage with Japanese equities, particularly on a currency-hedged basis, in our view. WisdomTree is a leading provider of Japanese ETFs in the U.S. marketplace, with 10 Japanese equity strategies. Below we highlight a few investment themes that we think are worth considering as Japan plans its fiscal package:   1) Renewed Yen Weakness Favors Export Tilt in DXJ: Japan’s globally oriented companies like those in DXJ have suffered this year on the yen’s surprising strength, as capital goods and car companies see their profits eroded from a strengthening currency. With not only Japan discussing major stimulus, but also China adding to infrastructure spending projects that look to increase Chinese high-speed rail by more than 50% by 2020, capital goods companies from Japan should be beneficiaries. Estimates for spending from this Chinese stimulus package could be as much as $180 billion a year or $900 billion over five years. China and the U.S. are Japan’s largest export markets, and stimulus in China should help sentiment for Japan’s global exporters.   2) Local Economy with Small Caps, DXJS: Small-cap companies are more tied to the local economic dynamics in Japan than the large-cap multinationals are. If the fiscal stimulus helps support local economic initiatives, an improving and tight labor market could continue to support wages for the young generation. While Japan certainly has a declining work force, the young employees in Japan are seeing wage growth that supports consumption. For a domestic focus on Japan, we’d note that the revenue from Japan for Japanese small caps in DXJS is currently more than 75%, while large caps in the MSCI Japan Index blog have approximately 59% of their revenue from Japan.¹   3) Real Estate to Benefit from Negative Interest Rates, DXJR: We recently conducted a roundtable on Japanese investment themes that suggested that real estate, a pure local-economy story, is the prime beneficiary of negative interest rates given how much borrowing costs are a factor in the real estate business. But the case for real estate goes beyond low borrowing costs. A real estate CEO we spoke to suggested the gap between fundamentals, which are extraordinarily positive, and sentiment, which is extremely cautious, is the biggest he’s seen in his career. And that gap is creating opportunities. DXJR has been our best performing currency-hedged Japanese ETF in 2016 through July 21.²   4) Quality and Corporate Governance Theme, JHDG: Much has been made about the Bank of Japan’s initiative recently to ask ETF providers to create new ETFs geared to capital expenditures and hiring. As a long-term investment proposition, we believe companies that are managing their balance sheets and businesses in a way to deliver high return on equity and better growth prospects tend to be rewarded more than companies that are just increasing spending and capital expenditures. Our quality dividend growth family selects dividend-paying stocks that are among the higher-profitability and higher-growth companies in Japan. Japanese companies have been among the best dividend growers in the developed world over the last three- and five-year periods, a trend we see continuing. We believe the companies in JHDG have prospects to continue providing capital stewardship through dividend growth. We have written about how quality, as a factor, has been a strong performing factor internationally, and it has been true equally for Japan in 2016.     Unless otherwise noted, data source is Bloomberg.           ¹Sources: WisdomTree, FactSet, Bloomberg, with data as of 12/31/15–7/21/16. ²Sources: WisdomTree, FactSet, Bloomberg, with data as of 12/31/15–7/21/16.