Say 'Ohayō Gozaimasu' To The Place To Be Outside The U.S.

Japan is often a predictable destination for investors looking to diversify beyond the confines of U.S. borders. Even with the yen's gyrations and bouts of being favored as a safe-haven play, Japan has been one of the few markets to keep pace with the S&P 500 over the past several years.

That is on a currency hedged basis. Up nearly 4 percent this year, the WisdomTree Japan Hedged Equity Fund DXJ has surged more than 31 percent over the past year.

Ohayō Gozaimasu, Japan!

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.

However, Japan, the world's third-largest economy, is home to some of the developed world's least expensive stocks. Some big-name institutions see more upside coming for Japanese equities as the post-election dollar rally continues and the yen falters.

WisdomTree Commentary

In a note out Monday, WisdomTree pointed out that DXJ is one of the few assets that has competed well with the S&P 500 over the past four years.

“One of the critical reasons WisdomTree still remains bullish in our outlook for Japan is that over this four-year period, the country kept pace with the U.S., and the U.S. market was driven by equity markets expanding in valuations (based on metrics like price to expected earnings, while Japan was driven by valuations contracting),” said WisdomTree Research Director Jeremy Schwartz in a note. “Further, political stability is a hallmark of Japan today, while corporate governance has helped improve returns to shareholders through accelerated dividends and buybacks.

Among large-cap Japan ETFs, DXJ remains one of the most compelling options, because the fund tilts directly toward Japanese exporters that benefit from the weak yen. For example, DXJ allocates over 47 percent of its combined weight to consumer discretionary and industrial stocks.

Importantly, Japanese earnings growth coupled with ongoing yen weakness could serve as catalysts for the next leg higher for the country's equity markets and ETFs such as DXJ.

“Japan earnings estimates, in our opinion, are likely to also be revised higher in the coming months. Corporate Japan’s forecasts and much of the analyst expectations for earnings were based on assumptions of ¥103 to the U.S. dollar. With the current rates of ¥115, we might see 8 percent to 10 percent earnings growth from Japan, based on some work from our Japan CEO, Jesper Koll,” added Schwartz.