Yen Weakness May Provide Support to Earnings
The products that Japanese companies sell worldwide become cheaper to foreign buyers as the yen weakens against their domestic currencies. As these products become relatively cheaper across the globe, the demand increases, allowing Japanese companies to sell more. The companies eventually must bring the money back to Japan, and when they do, they are able to exchange the foreign currencies against more yen. This process has allowed many Japanese companies to report increases in sales and profits. Keeping valuation multiples constant, increases in company profitability potentially translate to higher equity prices.
J.P. Morgan’s Japan strategist Jesper Koll conducted an excellent analysis of how he expects earnings to fluctuate for various levels of the yen exchange rate.
• Earnings Expectations Increase with Yen Weakness:Given a 10-point move in the yen from ¥90 to ¥100, J.P. Morgan would expect a similar percentage increase in earnings from 76 to 84, or about a 10% increase in earnings. If the yen depreciated from ¥100 to ¥110, J.P. Morgan estimates another 10% increase in earnings, from 84 to 93.
• My base case scenario is that the yen will continue to depreciate against the U.S. dollar and EPS should increase as a result. J.P. Morgan’s model gives at least one guide for how aggregate Japan earnings might respond to this yen change.
Hedge Yourself Against Further Weakness
Although Japanese exporters may potentially benefit from further yen weakness, it does not help U.S. investors who are not hedged. When investing in foreign markets investors are exposed to movements in equity prices as well as movements in currency. Japanese equities are positive year-to-date, but the yen weakness (against the dollar) has detracted from the total return, unless the currency was hedged. It is, of course, impossible to know with certainty if the yen will weaken or strengthen against the dollar in the future, so hedging currency also helps mitigate the risk of currency impacting returns by isolating simply the equity exposure.
The WisdomTree Japan Hedged Equity Index is designed to provide exposure to Japanese equity markets while at the same time neutralizing exposure to fluctuations of the Japanese yen movements against the U.S. dollar. The Index consists of dividend-paying companies incorporated in Japan that derive less than 80% of their revenue from sources in Japan. By excluding companies that derive 80% or more of their revenue from Japan, the Index is potentially tilted toward export-oriented companies with a more significant global revenue base.
Jeremy Schwartz is director of research at WisdomTree Investments (NasdaqGM: WETF). This post was republished with permission from the WisdomTree blog.