Time For The Topix And Relevant ETFs

Against the backdrop of safe-haven demand for the yen, Japanese stocks and exchange-traded funds are struggling this year, but the scenario could improve in the fourth quarter.

On the surface, many investors might criticize the lack of inflation, weak macro data and Japan’s corporate exposure to emerging markets as good reasons why Japan’s equity market should have played catch up. However, investors are ignoring a really significant divorce between Japanese earnings revisions and a number of macro indicators.

It's Not All Bad News

What is being overlooked is that some corners of the Japanese equity market are actually performing well this year. For example, the WisdomTree Japan SmallCap Div Fd (ETF) DFJ is up a very solid 9.2 percent year-to-date, a data point that is being glossed over as global investors focus on the yen's strength and subsequent weakness in Japanese large caps.

DFJ offers a direct avenue to Japanese dividend growth, which has been improving in recent years, as cash-rich companies in Asia's second-largest economy have been parting with some of that cash to boost dividends and buybacks.

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Some market observers see opportunity with Japanese stocks in the fourth quarter, particularly as the Bank of Japan and other major investors look to support the equity market in the world's third-largest economy.

Further Catalysts

Again, there are data points that bode well for Japanese stocks and ETFs such as DFJ. Those include growing dividends and rising share repurchase programs. Additionally, other metrics indicate DFJ could be a credible value play, not a value trap.

“The central bank, pension funds and corporations are buying 5 percent of the equity market float,” said Rareview Macro founder Neil Azous in a note out Tuesday. “That number is heading to 6 percent over the next 12–18 months as corporations increase their pace of buying on account of having even larger cash balances than the United States.”

Another potential catalyst for Japanese stocks and ETFs is that global investors are currently under-allocated to the asset. A reversal of that trend could propel Japanese equities higher.

“Offshore investors do not hold a long position in Japanese equities,” added Azous. “The recent policy initiatives are supporter for a weaker currency. There is no US presidential election to contend with into the end of the year.”

The $396.4 million DFJ has lagged the Russell 2000 by 1.5 percent this year, but the Japan ETF has been less volatile than the U.S. small-cap benchmark by 1.5 percent, implying a fair trade in terms of risk-adjusted returns.

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