US investors should be careful betting on Japan’s stock market boom

Between the news from the Ukraine and the latest pronouncements from the Federal Open Mouth Committee, you’ll be forgiven if the recent fall of the yen has escaped your attention. But the impact of currency moves has implications far beyond Japan’s economy and markets.

During March, the yen went from 115 to the dollar to 125 before settling back to around 122. (A higher number indicates a weakening of the Japanese currency, as it takes more yen to buy a dollar.) The simple explanation is that the Federal Reserve initiated increases in interest rates, while the


Bank of Japan
kept his policy ultra easy. That included buying unlimited amounts of Japanese government bonds, or JGBs, to cap the benchmark 10-year index yield at 0.25%, which meant electronically printing more yen. and, in turn, depressing the currency’s exchange rate.

Injecting more money is often a drug to improve asset price performance, so it is not surprising that the


Nikkei 225

It gained 4.88% in March, its best month since November 2020, when global markets soared on the announcement of an effective Covid-19 vaccine.

But currency-adjusted returns are what count for those keeping track in dollars, as our dear late former colleague Peter DuBois, the original International Trader columnist, would remind us. For American investors in the


iShares MSCI Japan

exchange-traded fund (ticker: EWJ), the yen’s slide resulted in a 0.9% drop in March despite the rally in Tokyo. US investors who want to invest in Japanese stocks without the currency risk should consider


WisdomTree Japan Hedged Equity

ETF (DXJ), which gained 3.5% in March.

“Overall, yen weakness is to Japan’s advantage,” Bank of Japan chief Haruhiko Kuroda recently declared, a sentiment apparently echoed by the Nikkei’s advance. That may have been the case in the past, but Macro Intelligence 2 Partners argues that the Japanese economy is radically different than it was in the 1980s. Previously driven by exports, it now runs a current account deficit, while still depending oil and imported food products.

Rising energy and food prices it’s doubly painful for Japanese consumers, who must pay for these necessities in depreciating yen, and for companies that rely on foreign-sourced materials. Shunichi Suzuki, who heads the Ministry of Finance, says the yen’s weakness should be watched closely to see if it is having a negative effect.

The impact of the weak yen could extend beyond Japan, writes Albert Edwards, global strategist at Société Générale. The BoJ’s efforts to cap JGB yields could be tempering the rise in US and Eurozone yields. Yen-based investors don’t care if US inflation is at 8% or 18% if they can buy 2.5% US Treasuries, much more than JGBs offer . But they do care if the extra performance is offset by currency moves, a tailwind for them lately.

Previous bouts of yen weakness have had a domino effect. The yen’s slump in 2013-15 pushed down competing Asian currencies, resulting in the disturbing August 2015 devaluation of the yuan by china As China’s economy was hit by a draconian lockdown in Shanghai in reaction to a relative handful of Covid-19 cases, Chinese monetary authorities have been easing domestic policy. But the effectiveness of this move is clouded by the strength of the yuan.

“One thing to watch out for, especially in today’s febrile geopolitical environment, is whether China is ‘forced’ to devalue yet again due to yen weakness,” Edwards writes in a research note. It will be recalled that the sudden crash of the yuan in 2015 caused a global mini-crash that spread to Wall Street.

However, it is Japan itself that suffers most from its longstanding weak yen policy, argues William Pesek, an esteemed former Barron’s colleague and now a prolific journalist based in Tokyo. The BoJ’s aggressive balance sheet expansion since 2013 under Kuroda (it is now larger than Japan’s $5 trillion economy) boosted gross domestic product and corporate profits. But it failed to boost productivity, innovation or wages.

“Two decades of the most generous corporate welfare possibly anywhere, courtesy of a weak yen, did the opposite,” Pesek writes scathingly in his latest Nikkei Asia column. “Why bother to restructure, recalibrate, reimagine, or reanimate the innovative spirits that once displayed


Apple,


Samsung Electronics,
and


Tesla
How do you do when the central bank is backing you?

Furthermore, Japan lags behind even some developing nations, such as India and Indonesia, in producing tech unicorns. “Since Masayohsi Son’s SoftBank Vision Fund invests heavily in startups from Bangladesh to Brazil, very few of its bets are in its home market,” he adds.

If currency debasement were the path to prosperity, Argentina and Venezuela would be booming, says Pesek. The yen’s weakness is a symptom of Japan’s decades-long lethargy, not its cure, and certainly not a reason for optimism on Japanese stocks.

write to Randall W. Forsyth at randall.forsyth@barrons.com

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