EWJV - EWJV: Financial Conditions Should Stay Strong In Japan

2023-05-18 01:40:25 ET

Summary

• EWJV is exposed heavily to industrial and consumer discretionary stocks that have a fair bit of exposure to the rate situation in Japan.
• Due to high levels of Japanese public debt, as well as the low levels of consumption rates in Japan compounded by demographics, rates will stay low.
• In other words, the speculation around BoJ leadership change is not very likely to lead to greater hawkishness, despite Ueda's record.
• I think Japanese consumer conditions will comparatively improve relative to the rest of the Western world. Japanese value stocks are a high priority.

The iShares MSCI Japan Value ETF ( EWJV ) is a Japan focused ETF with lots of quintessential industrial and automotive exposures that are hallmarks of the Japanese economy. A critical factor for the portfolio are the Japanese financial conditions, since these exposures depend on financing conditions to support investment cycles and financed purchases of automotive and heavy machinery. Moreover, the financial exposures in Japan are less exposed on the asset side, besides to US bonds, due to the much more accommodative financial conditions. Markets have been holding the view that Ueda's takeover of BoJ leadership signals a hawkish turn, but we think structural factors make raising rates in Japan too untenable, especially as we reach the tail-end of the global battle with inflation, the cost being borne more by countries other than Japan.

EWJV Breakdown

The automotive and industrial exposures are visible from the get-go with the top holdings:

And the sector exposures are as shown below:

It's worth comparing the EWJV to the iShares MSCI Japan ETF ( EWJ ) at this point since they are close cousins in the ETF space. The EWJ is a broader ETF, and also more costly to maintain, with a 0.5% expense ratio compared to EWJV's 0.15%. EWJ has a lot more IT exposure, and less value-style exposures in industrials and financials, which have a higher representation.

EWJ is a solid pick as well. At a 13x PE to EWJV's 10x PE, it still represents good Japanese value, and the additional secular growth provided by the IT exposures. EWJV is going to be more exposed to the dynamics of the financing environment, both because of its financial exposures and all the industrial and consumer cyclical exposures.

Bottom Line

Financing conditions are the main consideration for this ETF. Ueda is the new BoJ head, and he was seen by markets as being a more hawkish influence. In the end, he maintained the highly accommodative Japanese monetary policy .

Wealth destruction cannot be avoided from the Ukraine war for whoever decided to cut ties with Russia including Japan. Japan has taken its lumps with a very depreciated Yen, which is the consequence of not tightening monetary conditions with the rest of the world. The weaker Yen means imported inflation, but in general, the consumer environment is much more predictable in Japan, also because their COVID-19 lockdowns were much lighter. They are benefiting from the fact that other countries are on the front-lines of putting pressure on their financial position for the benefit of everyone with some commodity depreciation for commodities connected trading on world markets.

In their financial exposures, there doesn't have to be too much concern of pressure of higher rates on credit markets. Japanese financials often own some US securities, which can be a negative, but it's by no means a disaster-level exposure, and they have the staying power to see those securities to fruition on the fixed income side.

In industrial and automotive, these markets are demand-dependent on the financial markets for survival.

The reasons we are confident in continued monetary accommodation are two structural ones. The first is the very high levels of Japanese government debt . The levels are higher than any other G-7 country at closer to 300% of GDP. The government cannot really afford to have higher domestic rates, especially when government spending on infrastructure and the sorts are important to try to tackle persistently low rates of consumption and to deal with demographic issues like hyper-urbanization and low fertility rates. The second reason is the fact that extremely low consumption rates won't be helped by higher financing rates, and in general, the levels of inflation in Japan are pretty limited, with only imported categories being substantially subject to higher prices. Japan cannot afford to disincentivize consumption when it is already so low.

We are overweight on Japan, especially on value style stocks where resident tech stocks trade at levels more consistent with the typical US tech company, while industrial stocks tend to trade a lot cheaper. One of the reasons is the favorable credit environment in Japan, where we are still wary of what a credit-addicted economy in the West will do now that the era of easy money is over. EWJV captures those exposures, and with a 10% earnings yield in a structurally interesting market, we'd prefer it over other more global or US value ETFs. The low expense ratio at 0.15% is also favorable.

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