Interest rates recently rose in Japan. It’s likely the Federal Reserve will soon move in the opposite direction in the U.S. Contrary to what some investors believe, diverging monetary policy between the two countries doesn’t dent the case for Japan stocks.
For example, the large-cap MSCI Japan Index is higher by 6.11% for the month ending Sept. 6. But investors could have done even better with Japanese small-caps. Over that month, the WisdomTree Japan Small Cap Dividend Fund (DFJ) surged 7.76%. When Japanese stocks slid last week, DFJ performed significantly less poorly than did the MSCI Japan Index.
Interestingly, it appears as though the Bank of Japan’s (BOJ) surprise interest rate hike was a boon for Japan small-caps. And, like their U.S. counterparts, they are more domestically focused. For three months ending Sept. 6, the MSCI Japan Index lost nearly 1%. In that time frame, the DFJ gained 3.4%. The ETF also easily topped major U.S. small-cap benchmarks over that span. Good news: Some experts believe there’s more to come for Japan small-cap stocks.
DFJ Has Tailwinds
For roughly three decades, Japan stocks dithered, offering global investors little reason to get involved. That changed over the past few years. That’s because major large-cap benchmarks in the country reclaimed highs last seen in the late 1980s. However, Japan small-caps, including some DFJ holdings, have been sturdy for far longer than many investors realize.
“Japanese small-cap stocks have outperformed large caps handily over the last 20 years (9% compound annual growth rate for small caps versus 7% for large caps). Japan’s move from deflation to inflation should be a boon for revenue growth at domestically focused companies,” noted Daniel Morris of BNP Paribas.
A Potential Positive for Smaller Stocks
DFJ offers other benefits, including leverage to Japan’s rising inflation. While rising inflation was an obvious drag on domestic equities in 2022, including small-caps, decades of deflation in Japan had a similar impact.
With tolerable inflation taking hold in the country, the good news for DFJ member firms is that wages are rising on par with or in excess of that inflation. That means more Japanese citizens have more cash to allocate to discretionary spending. That’s a potential positive for smaller stocks and relevant to investors considering the $249.1million DFJ because consumer cyclical is the ETF’s second-largest country weight, at 17%.
“Inflation should also encourage consumption as Japanese households no longer have an incentive to delay purchases in the expectation that prices will fall in the future. Wages are rising at an accelerating rate, putting more money in consumers’ pockets,” added Morris.
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