Two Ways to Play Land of the Rising Sun

03/13/2007 12:00 am EST


Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carlton Delfeld, editor of Chartwell Advisor Global ETF Report, says two ETFs should help investors profit from renewed strength in the Japanese yen and Japanese stocks.

Rydex Investments has launched a Japanese yen exchange-traded fund or ETF (FXY), the latest of eight that the firm offers to advisers. The [currency-based]  ETFs offered track the euro (FXE), the British pound (FXB), Swiss franc (FXF), Swedish krona (FXS), Mexican peso (FXM) and Canadian (FXC) and Australian dollars (FXA). Rydex also offers a mixed foreign-currency ETF. All of the currency ETFs invest via demand deposit accounts.

Japanese interest rates are still very low relative to Europe and America, with the Bank of Japan's (BOJ) rate at about 0.25% and ten-year notes at 1.7%. As I expected, the Japan benchmark rate was increased this month to 0.50%. Any rebound in the Japanese economy could strengthen the yen and an announcement is expected next week that GDP growth in the fourth quarter of 2006 was a surprising 3.5%.

Japan's postal system is really the world's largest financial institution, with assets estimated to exceed $3 trillion, representing more than 50% of Japan's GDP. Starting this October, it will be privatized step by step over the next ten years. This will move deposits from government accounts to private accounts and perhaps encourage Japanese investors to put more cash to work in stocks. Roughly 53% of Japan's household assets are now in cash and deposits compared to 11% for American households.

This huge amount of cash sitting on the sidelines is just one more reason not to write off Japanese ETFs such as the iShares MSCI Japan index (EWJ), which are full of world-class companies at the heart of Asian and world growth.

Many are advising that Japan funds or ETFs, such as EWJ, should make up six to ten percent of most equity portfolios. Japan remains a major world market unlike any other. For one thing, it is far below its peak of the late 1980s. The Nikkei 225 soared to its all-time high of 38,915.87 points on December 29, 1989. Ten years ago it was hovering at 21,000. In early 2003 it dropped as low as 7,600. Today it has recovered to
over 17,500.

Japan represents about 60% of all Asian market value. I have a 20% Japan allocation in Asian portfolios, which I think is about right. Japan still trades at a premium to other major markets. At the end of 2006, the Nikkei 225 [traded at] a price/earnings ratio of 21.5x, compared to just over 14x for the FTSE All Share and around 18 for the Standard & Poor's 500, America's index of largest companies. The consensus is that the Japanese economy will continue growing at a steady pace and the chance of s stronger yen could  also boost returns for global ETF investors.

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