DBJP: Large Cap ETF Is Export Led, Disadvantaged On Yen Rally

seekingalpha08-03

The Yen hedge has not been in holders' favor lately as the currency has rallied.Importantly, the Japanese indices themselves are negatively correlated to the Yen as large cap stocks have large foreign...

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Best to pick domestic exposures with resilient consumer markets.   Kei Uesugi The Xtrackers MSCI Japan Hedged Equity ETF (NYSEARCA:DBJP) is an ETF that follows a broad index of the Japanese market with the benefit that it is Yen-hedged. In our last coverage, we focused on the possible establishment of a virtuous cycle in prices to cure the persistently low Japanese inflation, which is a primary strategic consideration of the BoJ. We asserted that this would eventually become the basis for hawkishness if it came to pass. While the jury is still out on whether there will be a virtuous cycle in prices, the Yen has rallied on a combination of Fed dovishness and BoJ hawkishness as they execute another small rate hike. The issue for DBJP is the negative correlation between the Yen and the performance of the stocks. With the Yen declining, and Japanese indexes being export led, DBJP is not benefiting from the rallying Yen while suffering from a decline in the index. We are still overweight Japan, but we think selectivity is key as a more hawkish streak becomes more evident. Although we don't totally rule out some Yen downside from here either. DBJP Breakdown Industrials and consumer discretionary dominate the portfolio.   DBJP sectors (Xtrackers by DWS) The big industries in those sectoral allocations are automotive, automotive parts, heavy equipment export, semiconductor equipment and semiconductor export, as well as industrial electronics production and export. Export figures had been lending strength to Japanese GDP thanks to the weak Yen, though domestic consumption had suffered on imported inflation from a weak currency and general economic wariness. But for the Yen-denominated index, a weak Yen was good, and the DBJP was hedged for the Yen decline that was required to get the market to rally. The winds have turned in a couple of ways. Firstly, major portfolio components like Toyota (TM) have tumbled on an earnings miss. In general, while Japanese car manufacturers have benefited from significant share gains in automotive markets, there is some turning now in the cycle for automotive with high-interest rates and inherently leverage-driven markets slowing down a bit. But beyond the specifics, the BoJ has decided that there is enough visibility around a virtuous cycle in wages and prices (wage-price inflation spiral would be unvirtuous anywhere else) thanks to the union-negotiated wage hikes of around 5% or so to warrant a small hike of 0.15%, with rates now at 0.25%, which is still small and relatively insignificant on the general economy in terms of interest pressure, but is a signal that the Yen's weakness is not terminal. The BoJ was likely also motivated to do this because carry trade activity, in which the Yen is essentially shorted to take yield in other currencies, was having a huge impact on the currency's value as major leverage went into selling the Yen. Bottom Line In our last coverage, we couldn't have imagined the Yen getting cheaper. It did, so much so that its recovery has only returned it more or less to levels from when we covered DBJP last. But the arguments still apply, which is that a Yen-hedge is obviously not what you want when the Yen is appreciating. DBJP is especially not what you want because an appreciating Yen also means the index is falling. While the rate increases don't have a large effect on the cost of capital and on the earnings of Japanese companies or disposable incomes of households, it seems to have changed the narrative around the Yen. There was some dissent at the BoJ, citing continued economic uncertainty, but Ueda's dormant hawkishness has finally awoken as Japan plots its course to reduce bond buying and to slowly normalize monetary policy. With many stocks falling on the Yen's strength, including many that shouldn't have, the time for selectivity has come, and we would eschew any Japanese ETF in favor of specific picks. As far as the value of the Yen hedged incrementally with DBJP, it is anyone's guess. Last time the rate hike wasn't large enough and carry trades continued despite it. However, hawkishness is more evident this time, especially as the BoJ decided to anticipate the outcome of the wage hikes this year and promise more interest rate hikes if they come as expected, plotting a path of hikes. We are not confident in the Fed's rate cutting plans as inflation is still high. That may impact the speed of the monetary policy convergence from the US side, and there could even be some Yen downside after its rally as carry trades possibly resume. The rate hikes were small. But the vigor of the Yen lately may be enough to deter renewed carry trading, and the hawkish streak as the BoJ hikes rates despite dissent and uncertainty could do so as well.  We think that for Japan, the trick is to pick stocks whose markets are domestic, but safe from weak consumption so you don't have to bet on consumer vigor in Japan which is always stymied by demographic considerations and may not follow from wage hikes, the concern of some of the dissenting BoJ members. Leverage isn't a big factor since the interest rate hikes will be slow and slight, even if definitive. Large cap stocks in Japan have large foreign markets, usually in the US. The automotive picks and stocks like Nintendo (OTCPK:NTDOY) and Sony (SONY) are examples of that. If the Yen holds its ground or even continues to rally, that would be bad for DBJP as large caps would fall and there'd be no FX benefit. Unhedged investments in mid- and small-caps may finally have their time, although the risk is that allocators tend to ignore those stocks, and liquidity gets thinner faster in Japan as you go into the lower echelons of the market.","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":"4.29.1","shortVersion":"4.29.1","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/2456266852"}