In the first quarter of 2015—a year ago—there were few ETF strategies more popular than the WisdomTree Japan Hedged Equity (DXJ | B-65), which attracted $2.6 billion in net inflows in that period. Investors had been flocking en masse to the currency-hedged portfolio of Japanese stocks since early 2014, really, buying into the notion that Japan’s Prime Minister Shinzo Abe’s plan for reform was going to end 25-plus years of deflationary pressure, and spark a new era of growth.
But in the first quarter of this year, there’s been a complete reversal of that trade. Bloomberg reported this week that since the beginning of the year, investors have already yanked more than $46 billion from Japan’s stock market, as it plummeted nearly 20%. And big investors too, such as BlackRock, it says.
DXJ has seen net redemptions of nearly $2.8 billion year-to-date, and the distaste for Japan exposure isn’t only linked to currency-hedged plays. DXJ’s nonhedged counterpart, the iShares MSCI Japan (EWJ | B-95), has now bled $1.65 billion in the same period.
Performance in these Japan ETFs is also faltering. Since the beginning of 2016, DXJ has now declined more than 11% to-date in a spectacular fall from mid-2015 highs. The unhedged EWJ is still holding onto 2% gains in the same period, but it too is struggling to find upside as investors give up on Japan, as the chart below shows:
Losing Faith In Abenomics
The main catalyst for the sudden bailout on this trade seems to be a simple loss of faith in Abe’s Abenomics—the three-arrow stimulus and reform program aimed at ending economic contraction in the country.
Abenomics has been implemented for more than two years now, and the Bank of Japan has shown itself to be committed to reaching its 2% inflation target—and staving off the recent strengthening of the yen—by expanding its stimulus program and introducing a negative interest rate policy earlier this year. It was a bold move. But it did little to encourage investors, who are growing worried that the plan has stalled and that it has failed to spur domestic consumption and economic growth as promised.
A look at the prevailing views on Abenomics today, from commentaries to blogs to news stories, paints a picture of investor disappointment, of missed opportunity by Japan’s leadership, of lack of imagination when it came to finding macro solutions to entrenched structural problems, and of pessimism for what lies ahead.
William Pesek, executive editor of Barron’s Asia, offered an interesting take—through the views of Paul Krugman and Joseph Stiglitz—into what went wrong, arguing that Abenomics sought to “treat the symptoms of what ails Japan (deflationary pressures) and not the underlying illness (a complete lack of confidence in the future).”
Tax Increase First Misstep
The government’s first—and perhaps most notable—misstep was increasing taxes on a population that hadn’t seen any significant wage growth in nearly 25 years. It’s worth a read.
Since Abenomics started, the yen slipped more than 30% against the dollar—the perfect backdrop for a strategy like DXJ or the Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP | B-72). But year-to-date, the Japanese currency is up more than 10% relative to the dollar, as volatility and risk sentiment pick up. Look at this CurrencyShares Japanese Yen Trust (FXY | B-99) chart:
Charts courtesy of StockCharts.com
Japan Macro Advisors was already forecasting the end of Abenomics back in February. According to the Tokyo-based firm led by Takuji Okubo, managing director and chief economist, “The idea behind Abenomics was sound, but it was badly executed.”
“In theory, the policy package aimed to implement painful structural reforms while expansionary fiscal and monetary policies played the role of painkillers. In reality, no significant structural reforms were executed,” the firm said in a report. “In the meantime, painkiller policies were used in abundance, especially the monetary easing.”
According to them, the monetary easing that led to a weaker yen initially helped the bottom line of Japanese companies, particularly exporters. But it didn’t change their outlook on the economy.
“However, it seems that Japanese corporate managers did not mistake the short term benefits from the weak yen as an improvement in the long term competitiveness of exporting from Japan,” the report said. “Export volume from Japan hardly grew, as companies refrained from shifting production capacity back to Japan.”
Their conclusion, if right, could mean the outflows from Japanese equities is not over. As they put it, “Is Abenomics salvageable? We do not think so, but public policy makers will try.”
Bullish Pockets In Japan
Still, there are some Japan bulls. WisdomTree’s Jeremy Schwartz says that “Japan could represent one of the best equity markets over the coming years.”
In a recent blog, he suggested investors who agree with that view should consider Japanese quality dividend stock ETFs, or those owning Japanese companies that have solid growth prospects and that are currently at attractive valuations.
Schwartz, of course, has skin in the game as the director of research for WisdomTree—the issuer behind DXJ and a lineup of other Japan-focused strategies. But every market has two sides, and for what it’s worth, WisdomTree was ahead of the game when it rolled out DXJ, and it has shown that it knows a thing or two about Japan.
Contact Cinthia Murphy at [email protected].