Over the past decade-plus, advisors and investors heard plenty about international equities being primed to outperform U.S. counterparts. They were left disappointed. Declarations to that effect are again prominent this year. However, things could be different this time around with Japanese stocks being a big reason why that’s the case. As of July 18, the widely observed MSCI Japan Index is higher by 17.1% year-to-date. Since the start of this year, Japanese stocks are among the best performers among developed market equities and are trailing the S&P 500 by a negligible margin.
Some investors may not want a dedicated Japan strategy. They may recall the lengthy spell of ex-US developed markets disappointing investors, and Japan’s long bouts with deflation. However, they might also want to nibble at resurgent markets in the Land of the Rising Sun. The Calvert International Responsible Index ETF (CVIE) is the cure as the exchange traded fund allocates almost 17% of its weight to Japanese stocks — its largest country exposure.
Structural Factors Support Japanese Stocks
It’s possible for a country to have a thriving economy and lethargic stock market, or vice-versa. However, the case of CVIE as an avenue to Japanese stocks is supported by structural improvements.
“As you may have seen, Japan’s economy and financial markets have attracted outsized investor interest this year,” noted Chetan Ahya, Morgan Stanley’s Chief Asia Economist. “We at Morgan Stanley Research have had a constructive view on the macro and markets outlook for some time, based on three pillars: A decisive shift away from deflation, structural macro reforms coupled with the improved corporate governance on the macro front and return on equity for the corporate sector.”
Integral to the Japanese equity thesis is the point that deflation in Japan is subsiding. In fact, by some estimates, inflation there is close to outpacing the levels seen in the U.S.
“The pursuit of Abenomics from 2013 onwards brought about a transition from deflation to low-flation and inflation managed to move a tad bit higher to an average of 0.5% from 2013 to 2019,” added Ahya. “In this cycle, we are seeing yet another shift in which Japan is decisively exiting deflation. Indeed, we see Japan transitioning into moderate inflation territory, where inflation averages 1 to 1.5% over the medium term.”
Japan is the one developed country in the world that could use a dose of moderate inflation. Therefore, this could be a positive spark for CVIE.
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