HEWJ: The Yen Hedge Is Still Paying Off

seekingalpha05-31

The iShares Currency Hedged MSCI Japan ETF has successfully taken advantage of the rise in Japanese indices while avoiding the depreciation of the Yen.The ETF benefits from a weak Yen, particularly in...

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Sustainable Japanese inflation is needed.Also, the BoJ will have to be effective in using intervention to upset carry traders while they buy time for the shunto season wage increases to take effect.HEWJ still looks alright on general Japanese market optimism, but we would get out of the way when signs of Yen appreciating comes.Susumu Yoshioka/DigitalVision via Getty Images The iShares Currency Hedged MSCI Japan ETF (NYSEARCA:HEWJ) has been successful in taking advantage of the Yen-denominated rises in the Japanese indices while avoiding the primary pitfall in the last years, which was the severe depreciation of the Yen primarily driven by heavy selling from carry traders. Our position at this point is that there still aren't any major upward catalysts for the Yen, which makes the hedge within the EWJ against a depreciating Yen somewhat helpful. Moreover, a weak Yen, while possibly not very helpful incrementally anymore, doesn't harm the Yen denominated performance of the underlying unhedged (EWJ) index. Then, EWJ investors benefit from continued appreciation of corporate governance changes at Japanese large-caps. EWJ still looks alright. HEWJ Breakdown HEWJ is the basic iShares Japan ETF (the EWJ) plus hedges against the Yen. We've covered the EWJ in the past, focusing continuously on corporate governance changes in Japan. The EWJ is focused on large-cap issues, a lot of automotive companies and automotive parts, as well as other industrial majors from Japan whose brands are known the world over, like Mitsubishi (OTCPK:MSBHF). In addition to industrial and consumer discretionary names, there is quite a lot of semiconductor exposure, which picked up at the beginning of the year thanks to demand for chips, and financial exposures. HEWJ Sectors (iShares.com) The industrial and automotive exposures are the major export industries of Japan and benefit from a weak Yen to a substantial extent. Local production and foreign markets means major FX benefits. On the flip side, severe declines in the Yen have also meant that imported inflation is kicking in which is causing wage growth hurting bottom lines in some cases, with the shunto this year being intense at over 5% union wage increases now secured. Also, imported inflation is hurting business to the extent that it faces the domestic market, where consumer sentiment is weak consistent with a recessionary environment. The EWJ benefits from a weaker Yen, although the further it weakens, the more wage inflation and consumer sentiment will start to matter for the performance of the constituent elements. The HEWJ benefits even more than the EWJ due to the fact that the nominal exposure to the Yen in the ETF is being hedged, so a weaker Yen improves business fundamentals of a lot of constituent elements like automotive and also revalues the hedge. For financials, which are almost entirely a Yen denominated exposure, the hedge offsets the direct impact that a weakening Yen would have on the performance of those stocks in a USD or EUR account. The performances of these stocks would be almost parity to a US or European retail financial business whose NIIs weren't rising much, plus the idiosyncratic issue of improving Japanese corporate governance which has started to expand the market's multiple. Bottom Line A way to think about the HEWJ and its relationship to the Yen is that the EWJ benefits from the Yen decline, and the hedge within HEWJ makes HEWJ even more of a short play on the Yen. So investors in the HEWJ should be thinking about when the party might end for the Yen shorts. But first, why is the Yen declining?  The US consumer has been resilient, allowing the dollar to offer high rates and yields as the Fed tries to dampen consumption with higher rates. The Japanese consumer has been cautious, and the inflation wheel turns slowly in Japan as demographics take effect. Inflation hasn't been high enough to justify a tighter monetary policy. The Yen yields almost nothing, and has just come out of negative territory in baseline rates. The carry trade has been extremely popular and profitable, with a lot of liquidity, where people borrow Yen, sell it and buy dollars to hold dollars for yield. The yield differential plus the diverging performance of the Yen and higher yield currencies like the EUR and the USD have added to the performance of the simple carry trade.  There are a couple of ways the carry trade could turn around. Firstly, there was the wage negotiation season that yielded more than 5.2% for major companies, and way over 4% across the board, even at relatively smaller companies. It will be pivotal if these wage increases actually impact consumer spending, as inflation will be taking hold and the inflation wheel will start turning. Also, companies in our coverage universe, albeit slowly, have started to raise prices, which is something that in many cases they haven't done in a generation. Finally, a weak Yen directly brings on the inflation through imported inflation, which could turn inflation faster and give space for the BoJ to normalize rates. We are seeing a lot of wholesale price increases on the basis of imported inflation. Importantly, the BoJ can intervene unpredictably and will do so with the objective of disrupting the carry trade as much as possible. While the carry trade is the main reason for the Yen decline and is attractive, it is being supported by leverage. These trades could unwind aggressively if both rate differentials shrank and the exchange rates reverted. This could be triggered by the mechanism we just described, or by an independent decline in EUR or dollar rates. The latter might happen in the case of deficit and public debt concerns to ease the burden, or maturity walls, even if they are being stepped out by refinancings and a strong corporate debt market, kicking in and helping along disinflation. Europe is already less inflationary, and cuts may be nearer.  We think that it may be better to get out of the way of HEWJ before these things happen, and May data showing wage increases translating into spending or spurring on further price increases at companies would be critical. However, we think there's a chance that the wage increases just mean more marginal saving. Then the HEWJ, whose 0.5% expense ratio is small for a foreign market and exposure to a hedge, could continue to be a good idea. Outside of the hedge, we continue to like Japan, as cash rich and low PBR companies have so much scope for buybacks and payout ratio increases. 16.27x is not that high of a multiple for the Japanese market and its export-led companies, who continue to win share in the US and EU markets thanks to the weak Yen and are benefiting from multiple expansion in cases where corporate governance changes are taking effect.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2439961475"}