In the U.S., investors can expect higher interest rates to drag stocks. That could well be one of the reasons domestics are scuffling in the first quarter. In Japan, the adverse effects of higher rates may be limited.
Take the case of the WisdomTree Japan Hedged Equity ETF (DXJ ). The marquee exchange traded fund focuses on Japanese equities. DXJ thrived last year, as the Bank of Japan (BOJ) boosted borrowing costs. Following a January rate hike by the central bank, Japanese rates reside at their highest levels in 17 years. To its credit, however, DXJ has soundly outperformed the S&P 500 over the past 90 days.
BOJ tightening is a response to an uptick in inflation in the Land of the Rising Sun — one long awaited by local and global investors alike. During Japan’s decades-long battle with deflation, Japanese companies and consumers remained tight-fisted. However, the latter are now spending more, due to the wage hikes that resulted from inflation.
Rate Catalysts for DXJ
Beyond elevated levels of consumer spending, renewed inflation in Japan, coupled with other factors, has prompted many retail investors to come off the sidelines and invest in stocks. That includes those held by DXJ. Indications of a favorable economic and monetary environment support their bullishness.
“We are now in an environment where not only does money have time value, but labour is also clearly scarce,” notes Nikko Asset Management. “Some of this market attrition can be viewed as healthy. While Japan’s ‘lost decades’ saw firms being subsidized to prevent unemployment from spiking, the current structural labour shortage has made such measures redundant. As a result, unprofitable firms can now leave the market without causing significant damage to households. However, interest rates do affect corporate financing with a lag when firms need to refinance. This is another reason why the BOJ has been very deliberate in the pace at which it is withdrawing stimulus.”
Japan's Firms Create Shareholder Value
Interestingly, higher interest rates aren’t acting as a detriment to corporate investment. Nikko points out that many companies in Japan are investing today — moves that could pay long-term dividends for DXJ member firms.
“Firms are indeed investing, not only in fixed assets to replace fully depreciated capital, but also in intangibles such as software in a bid to raise future productivity and allay labour supply shortages with automation and software solutions,” adds the asset manager. “Aided by the government’s enhanced corporate governance guidelines, these measures are creating shareholder value.”
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