Japan Macro and Flows Trade Back On

For much of 2014, Japan disappointed investors who were expecting greater stimulus from the Bank of Japan (BOJ). Prior to its most recent action on October 31, the majority of economists expected no additional action from the BOJ¹. The surprise easing announcement—which consisted mostly of tripling its purchases of exchange-traded funds (ETFs) and real estate investment trusts (REITs)² —sent the yen down and stocks up. The timing of these additional measures followed less monetary easing by the U.S. central bank³ as well as a transition from the Japanese Government Pension Investment Fund (GPIF)⁴. Talk about a powerful one-two punch—in one move, the BOJ offset worries about declining global liquidity out of the U.S. central bank and provided support to the GPIF (as it sells Japanese government bonds) while helping to boost equity purchases. This puts the focus back on the macro trades that worked well in 2013: a weak yen championed by BOJ stimulus, supported by inflows of more than $150 billion of foreign money into Japan’s equity markets that sent Japan’s markets soaring.⁵ So where should macro trades be focused? To start, we believe currency-hedged strategies are a great way to focus on the pure equity opportunity represented by Japan. As a reminder, traditional international exposures typically involve two sources of risk: equity risk and currency risk. Further, in the case of Japan, there is an inverse correlation between the yen and the equity markets—i.e., when the yen is on the decline (as it currently is), equities tend to rise. WisdomTree launched currency-hedged ETFs to help neutralize the foreign exchange rate risk from impacting returns to U.S. investors. Now let’s review the performance of different parts of the Japanese market, all on a currency-hedged basis.   Figure 1: Average Annual Returns of WisdomTree Japan Hedged Indexes (as of 9/30/14)   Figure 2: WisdomTree’s Japan Hedged Indexes Respond to the Bank of Japan’s 10/31/14 Announcements For definitions of Indexes in the chart, please visit our glossary. We see three main categories of interest for macro investors: 1) Exporters: that benefit from a weak yen. Japanese companies are expected to increase their focus on profitability metrics like return on equity (ROE), and more dividends and buybacks are expected as companies better manage the cash on their balance sheets to be more globally competitive. The WisdomTree Japan Hedged Equity Fund (DXJ), the ETF built to track the performance of the WisdomTree Japan Hedged Equity Index, is symbolic of this current market theme and offers investors access to its multinational exporters. 2) Small caps: are a more local Japanese economy play, and if Shinzo Abe, the prime minister of Japan, is successful at generating wage growth, these stocks could have some longer-term suport despite unfavorable demographic trends. And despite fears of a consumption tax hike, small caps were outperforming their large-cap global peers prior to the stimulus provided by the BOJ.⁶ The WisdomTree Japan Hedged SmallCap Equity Fund (DXJS), the ETF designed track the WisdomTree Japan Hedged SmallCap Equity Index, provides investors with access to this important segment. Further, the total price-to-book-ratio of this Fund is just 0.91—which means in aggregate terms the companies within the Index are selling at a price below liquidation value, or net assets⁷. Two hundred eighty-five of the 599 companies and more than 45% of the weight of the Fund have a price-to-book ratio less than 1.0.⁸ 3) Financials and Real Estate: Some of the most direct beneficiaries of the BOJ stimulus were financial and real estate companies, which were up more than 6% on the day of the announcement (see Figure 2). Real estate companies received direct support, as the BOJ was directly buying REITs. Real estate⁹ was the second worst performing sector prior to the BOJ announcement¹⁰, so it is not a surprise that it popped on the news. Financials¹¹ were the worst performer, down more than 10%¹², and that sector too popped more than 6% on the news. If the macro trades are back on, these two sectors may continue to be beneficiaries. The WisdomTree Japan Hedged Financials Fund (DXJF), the ETF designed to capture currency-hedged Japanese financials by tracking the performance of the WisdomTree Japan Hedged Financials Index, and the WisdomTree Japan Hedged Real Estate Fund (DXJR), the ETF designed to capture currency-hedged Japanese real estate by tracking the performance of the WisdomTree Japan Hedged Real Estate Index, provide investors with access to these opportunities. For more information on the rest of the Japanese sector offering, click here.         ¹Source: Andrea Wong, “Yen Declines to 7-Year Low on BOJ Monetary Easing,” Bloomberg, 10/31/14. ²Source: “Expansion of the Quantitative and Qualitative Monetary Easing,” Bank of Japan, 10/31/14. ³Source: Chris Matthews, “Are we Really Saying Goodbye to QE Forever?” Fortune, 10/29/14. ⁴Source: Adam Haigh, Yoshiaki Nohara and Shigeki Nozawa, “Japan Pension Fund Said to Unveil Asset Allocations Today,” Bloomberg, 10/31/14. ⁵Source: Bloomberg, for period 12/31/12–12/31/13. ⁶Sources: WisdomTree, Bloomberg, 12/31/13–10/30/14. ⁷Sources: WisdomTree, Standard & Poor’s, with data as of 10/31/14. ⁸Sources: Bloomberg, Standard & Poor’s, with data as of 10/31/14. ⁹Refers to the WisdomTree Japan Hedged Real Estate Index. ¹⁰Measured against the other WisdomTree Japan Hedged Indexes for the period 12/31/13–10/30/14. ¹¹Refers to the WisdomTree Japan Hedged Financials Index. ¹²Measured against the other WisdomTree Japan Hedged Indexes for the period 12/31/13–10/30/14.