Recent hawkishness from the Bank of Japan (BOJ) surprised many global investors with the subsequent pop by the yen sending Japanese equities and the related exchange traded funds into a tailspin.
Fortunately, that downside, though fierce, was short-lived, and Japanese stocks have rebounded off the early August lows. The other side of the coin is that some market participants are fearful that the BOJ is setting out on a new tightening cycle. This suggests that more rate hikes are in the offing. That doesn’t dent the broader case for Japanese stocks. It merely implies selectivity is needed. Enter the WisdomTree Japan Small Cap Dividend Fund (DFJ ).
For the 20 days ending Aug. 23, DFJ gained 4.3%, making it one of the best-performing Japan ETFs over that period. That confirms the advantages of the domestic focus of small-caps and DFJ’s lack of sensitivity to yen fluctuations. DFJ’s recent sturdiness is commendable, particularly against a challenging backdrop for Japanese markets, but that’s in the past. Investors want to know what the ETF could have in store going forward. The answer could ultimately prove positive.
DFJ Outlook Compelling
Drilling down on the outlook for Japanese small-caps, including DFJ holdings, investors will find attractive traits such as strong earnings growth and low valuations. Additionally, BOJ isn’t to quash risk-taking in Japanese markets. Instead, it’s merely trying to return monetary policy to a neutral stance.
“But with the market resetting, and as we look into the rest of 2024 and 2025, we see the two key engines of nominal GDP reflation in Japan and corporate reform still firing. As you lay out, the BOJ is trying to find its way back towards neutral; it’s not trying to end the cycle. And corporate governance is driving better capital allocation from the corporate sector,” noted Daniel Blake of Morgan Stanley’s Asia Pacific and Emerging Market Equity Strategy Team.
Blake noted that with the outlook still strong for Japanese stocks for the remainder of this year and 2025, it might be advantageous for investors to consider unhedged strategies. DFJ checks that box. He added that amid the lingering potential for more yen upside, investors may want to reduce exposure to Japanese exporters and emphasize domestically focused firms. DFJ obliges on that front, too.
“We do prefer domestic exposures relative to exporters. They’ll be better protected from any further strengthening in the Japanese yen. We also see a broad-based corporate governance reform agenda supporting shareholder returns coming out of these domestic sectors. They’ll benefit from that stronger, price and wage outlook with an improved margin outlook,” added Blake.
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