Take Caution of GDP Boost In Japanese ETFs (EWJ, SCP, VPL)

Courtesy of Kevin Grewal, Publisher, ETF Tutor

Japan witnessed its fourth consecutive quarter of economic growth enabling it to retain its position as the world's second largest economy after beating GDP expectations impacting the iShares MSCI Japan Index (EWJ), the iShares MSCI Japan Small Cap Index Fund (SCP) and the Vanguard Pacific Stock ETF (VPL).

The Japanese economy expanded by 4.5 percent in the third quarter of the year, exceeding analyst expectations by 0.6 percent and eating away at the nation's massive deflationary gap.  Furthermore, this expansion has led to Japan's Minister of Economic and Fiscal Policy to peg an estimated annual growth for the year at around 2.6 percent.

Although Japan has been exceeding growth expectations, it is important to take this outperformance with a grain of salt.  The aforementioned economic growth was primarily driven by increases in private sector inventories which further suggests that now inventories have been replenished, production cuts are likely to prevail.  Another driver behind increased GDP was an increase in domestic consumption driven by deadlines for subsidies for environmentally friendly vehicles and other economy boosting measures, which are expected to expire and have a negative effect on future consumption.  In fact, these trends are already starting to prevail as unemployment rates have started to worsen, industrial output has started to decline, retail spending has started to taper off and exports are slowing down.

To put further strains on Japan's economic outlook, corporations are starting to be more cautious in regards to investing and policymakers are hinting at increasing the consumption tax rate to procure money for the nation's aging population.

At the end of the day, when it comes to economic growth, Japan faces an uphill battle and is likely to lose its place as the world's second largest economy sooner rather than later.

• iShares MSCI Japan Index (EWJ), which allocates nearly 19 percent of its assets to the consumer discretionary sector.
• iShares MSCI Japan Small Cap Index Fund (SCP), allocates nearly 20.75 percent of its assets to consumer discretionary and is more correlated to the consumer sentiment in Japan than ETFs which track and hold large-cap stocks.
• Vanguard Pacific Stock ETF (VPL), which allocates more than 60 percent of its assets to Japan.

Disclosure: No Positions

Courtesy of Kevin Grewal, Publisher, ETF Tutor