Following a decades-long bout with deflation, Japan is the one major economy where inflation is welcomed. In fact, the return of inflation is a primary reason why stocks there have performed so well over the past few years.
In what could be good news for exchange traded funds such as the WisdomTree Japan Hedged Equity ETF (DXJ ) and the WisdomTree Japan Hedged SmallCap Equity Fund (DXJS ), inflation appears to be taking hold in Japan rather than acting as a temporary economic fad. For example, the country’s core consumer price index (CPI) jumped 2.6% year over year in March.
Entering this week, DXJ and DXJS were higher by 23.9% and 15.5%, respectively, year-to-date. As currency-hedged ETFs, DXJ and DXJS are benefiting from the weak yen. Likewise, global investors’ renewed enthusiasm for Japanese tech stocks is helping the WisdomTree ETFs. Both funds feature double-digit allocations to that sector. However, sticky inflation — a burden in the U.S. — could be a catalyst for Japanese stocks and related ETFs.
Japan's Inflation Situation Looks Compelling
There is something of note to investors considering DXJ and/or DXJS. There’s room for Japanese corporations to boost wages to outpace inflation. That’s a relevant point because consumer discretionary is the second-largest sector allocation in both ETFs.
“Firstly, the substantial wage hikes to be granted by companies are backed by increasing sales and profits. When the deflationary mindset was still prevalent, companies tended to limit capex, set a cap on wages due to an excess of labour, and reduce production,” noted Nikko Asset Management. “However, companies are now taking a more aggressive approach. They are finding it more beneficial to invest in capex and increase production. And amid the current labour shortage, to increase wages to retain and attract talent.”
Should the trend of rising wages in Japan continue, there would be tangible benefits for domestically focused sectors. That could potentially be a layer to the DXJ investment thesis. One that has long been supported by Japan’s strong export story.
Gains Seen in Japan Equities is 'Indisputable'
“The weak yen’s impact on the gains seen in Japanese stocks is indisputable, with exporters being the primary beneficiaries,” added Nikko. “However, other sectors with growth potential, such as travel and hospitality, banking, retail sales and real estate, could benefit from actual economic expansion. These sectors still have room for more growth as Japan continues to transition into an inflationary economy. Moreover, these sectors will be relatively immune to the yen’s fluctuations at a time when the BOJ’s monetary policy could trigger currency volatility.”
Consumer cyclical and financial services stocks combine for 35% of the DXJ roster. Those two sectors and real estate combine for roughly 29% of the DXJS portfolio.
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