Japan is experiencing an economic renaissance and those transformations are paying dividends for investors. For the three years ending June 6, the MSCI Japan Index returned 5%. Fortunately, market participants did much better when capitalizing on the yen’s weakness.
Over those three years, the WisdomTree Japan Hedged Equity ETF (DXJ ) returned a staggering 93.3%, trouncing unhedged Japan rivals and the S&P 500 in the process. Considering those gaps, it’d be easy for an investor to attribute much of DXJ’s leadership to yen weakness. They may also consider that the dollar benefitted from higher interest rates in the U.S. Those factors are true, but there’s more to the story.
It’d be unusual for an ETF to nearly double over three years simply due to currency fluctuations. That is to say, much of DXJ’s stellar three-year run is attributable to Japanese stocks proving responsive to encouraging trends in the local economy.
Inflation in Japan Boosting Case for DXJ
In the U.S., most don’t embrace inflation. But after decades of deflationary trends, it’s been somewhat beneficial in Japan. After a lengthy period of no raising prices or wages, Japanese companies, including some DXJ holdings, are taking a different approach and it appears to be working in the form of improving economic data and higher equity prices.
“Workers demand higher wages with higher inflation expectations and the corporate management accept their demand, as they also expect higher inflation,” notes Morgan Stanley Chief Japan Economist Takeshi Yamaguchi. “Japan’s labor market remains structurally tight and aggregated corporate profits are now at a record high level. In addition to the pass-through from prices to wages, we are beginning to see the pass-through in the other direction from wages to prices, especially in service prices.”
Those efforts and more are paying off. Japan’s nominal GDP growth in 2023 was its best rate in 32 years. DXJ responded in earnest to that growth. It surged 42%, better than double the returns offered by the MSCI Japan Index.
Further Spending on the Horizon
Another catalyst for the Japanese and potentially DXJ is the point that corporations there, including some residing in the ETF, are planning to spend more money this year. Yamaguchi observes that 2024 private sector capital expenditures could top the record set in 1991. Interestingly, some of the macro trends to which DXJ is levered are paving the way for that increased spending.
“Also, there are various other factors supporting domestic capex, such as real interest rates remaining low, the weak yen, the government’s new industrial policy supporting onshoring and semiconductor investment, and the need for digitalization and labor-saving investment on the back of structural labor shortage driven by demographic shifts,” concluded Yamaguchi.
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