Japanese Stocks: The Star of the Second Half (EWJ, DXJ)

Put your coffee down before you do a spit-take.

Japanese stocks third arrow

Japanese stocks are hitting fresh seven-year highs this week, and the Nikkei 225 has become a rising star of the second half of 2014.

There’s ample reason to expect more outperformance for Japanese stocks, but be forewarned that the big Japan exchange-traded funds — the easiest and most popular ways to play Japanese stocks — aren’t working equally well.

It sure wasn’t hard to pillory Japanese stocks or the investors who supported them earlier in the year.

After all, Tokyo appeared to be stepping on the accelerator and the brake at the same time. Abenomics’ aggressive and unorthodox monetary policies made some real progress, but nearly enough. Then, almost unaccountably, Japan hiked the tax on consumption to 8% from 5% last spring. That threw the Japanese economy under the bus in the second quarter. Heck, it contracted at an annual rate of 6.8%.

Japanese Stocks Roaring Back

And yet, halfway through the year, some contrarians thought Japan looked like a buy — and they were right. As we noted back then, BlackRock (BLK) was prominently and surprisingly bullish on Japan.

There were a number of parts in BlackRock’s bull case for Japan, but the most important for element right now is that Japanese equities were — and still are — pretty much the only bargains to be found anywhere among developed market equities.

Russ Koesterich, global chief investment strategist for BlackRock, advised clients recently:

“Focus on relative value. Given that most asset classes look expensive, I continue to prefer market segments that offer relative value. Currently, I see value in select international markets, particularly in Japan and emerging Asia. Despite Japanese equities hitting their best level since the fall of 2007, Japanese stocks are still relatively cheap.”

Just look at the tale of the tape: In the second half of 2014, the Nikkei 225 is up 11% vs. a 3% gain for the S&P 500. Of the two biggest ETFs tracking Japanese stocks, the WisdomTree Japan Hedged Equity ETF (DXJ) has gained 9% in the second half, while the iShares MSCI Japan ETF (EWJ) is up just 2%. But then, the DXJ hedges against the yen, which clearly has given it the upper hand in a year in which the dollar has soared and the yen has tanked.

More recently, Japanese stocks have simply smoked U.S. equities. The S&P 500 is off nearly 1% over the last month. The Nikkei is up more than 3%, as is DXJ. However, as for EWJ, it’s off about 1%.

More importantly, investors can expect Japanese stocks to keep gaining. Koesterich explains:

“The reason: optimism that weak economies will force the ECB and BOJ to expand monetary easing. Should this happen, both equity markets are likely to benefit. In other words, bad news might be good for Japanese and European stocks.”

Anyone who advised hedging against a U.S. September swoon with Japanese stocks may have sounded a little goofy at the time, but so far, they’ve very much had the last laugh.

DXJ, at least, might be worth another look for some fourth-quarter returns.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2014/09/japanese-stocks-nikkei-ewj-dxj/.

©2023 InvestorPlace Media, LLC