Not many international equity markets, particularly those large in scope, delivered better returns than the S&P 500 last year. But Japan stocks notched admirable performances.
While it lagged the S&P 500, the MSCI Japan Index surged 20.3% in 2023, but investors could have found even better U.S.-beating returns with the right Japan exchange traded funds. For example, the WisdomTree Japan Hedged Equity ETF (DXJ) surged 42% last year.
As a currency-hedged ETF, DXJ derived significant benefit from the yen being relatively weak last year. The Japanese currency is expected to strengthen this year as inflation takes hold in Japan. But some market observers believe Japanese stocks, including DXJ holdings, can move higher in unison with the yen. That could signal opportunity with the WisdomTree ETF.
DXJ Could Deliver Again
The backdrop of a stronger yen may not be as punitive to currency-hedged Japan ETFs as some market participants currently believe.
“So in contrast to these concerns, we believe that Japanese equities and the Yen can simultaneously rally in 2024, which will mean even stronger returns for unhedged dollar based investors than for the local index,” noted Daniel Blake of Morgan Stanley’s Asia and Emerging Market Equity Strategy team. “Our currency strategists forecast modest further gains in the Yen, with a pick up to 140 against the US dollar by end 2024 versus 143 today. And despite this, we see corporate earnings growth still achieving 9% in 2024, underpinned by nominal GDP recovery and corporate reforms.”
Blake added that there are several factors that are potentially constructive for Japanese stocks. For example, nominal GDP growth is back in Asia’s second-largest economy and the ravages of deflation — in place for more than three decades — are easing.
Then there are two factors where DXJ really answers the bell for investors: buybacks and dividends. Put simply, Japanese companies are under pressure to boost shareholder rewards, and many have been stepping up to that plate, bolstering the allure of DXJ along the way.
“The second driver is corporate reforms, which have been the most crucial driver of underlying Japanese equities performance, and we expect the trend improvement of return on equity to continue,” concluded Blake. “The sea change in corporate governance in Japan has led to major changes in buyback and dividend policies, which combined are almost quadruple the levels they were at ten years ago. And we’re seeing a broadening trend of underlying business restructuring underpinned by more engagement from investors, both foreign and domestic.”
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