Surging Japan ETFs ride new tailwind

Koll believes Japan’s TOPIX index can increase from the current levels around 18,000 up to 20,000, an increase of around 11 percent over the next six months.

“We maintain our bullish call for Japanese equities: Valuations are attractive, and positive earnings momentum is likely to keep going. Japan is not a “value trap.” In our view, profits can rise 25 percent in FY3/2018, which in turn suggest TOPIX at 2,000 is a reasonable fair-value target,” he wrote in a recent blog post.

While Koll likes Japanese stocks in general, he favors small-caps, which he says are much more focused on the domestic Japanese economy. In contrast, large-cap multinationals in Japan are much more dependent on exports to the United States and China.

The WisdomTree Japan SmallCap Dividend Fund and the iShares MSCI Japan Small-Cap ETF (SCJ) gained about 27 percent apiece this year, outpacing their larger-cap counterparts.

YTD Returns For DFJ, SCJ

Underpinning Koll’s bullish view on Japanese stocks is his enthusiasm about the country’s economy, especially in light of Prime Minister Abe’s victory two weeks ago.

Following the election, Abe is ruling Japan with the backing of a two-thirds super-majority in parliament, making for a stable government. Both fiscal and monetary policy are expected to remain stimulative, with the Bank of Japan buying enormous amounts of government debt.

“For all intents and purposes, in Japan there is no difference between [monetary] and fiscal policies anymore,” Koll said.

He pointed out that the Japanese Treasury issues about $40 trillion yen per year, and the Bank of Japan buys about $80 trillion yen. Shockingly, the Bank of Japan owns about half the entire debt load of the Japanese government.

“This is something you don’t see in normal economies. In history you only observe this type of debt monetization during times of war,” Koll said.

It’s the reason many analysts believe the Japanese yen is poised to decline against the U.S. dollar.

According to Brad Bechtel, currency strategist at Jefferies, Abe’s victory is a green light for the dollar to move higher against the yen. He sees the USD/JPY exchange rate moving from current levels of around 114 to 118 in the first quarter of next year, before potentially rising more from there.