2024-01-04 12:39:30 ET
Summary
- iShares Currency Hedged MSCI Japan ETF has outperformed the S&P 500 index in the past two years.
- Japan's economy is expected to remain robust in 2024, with a resilient services sector.
- The Bank of Japan is unlikely to reverse its dovish monetary policy, providing good buying opportunities for HEWJ.
Investment Thesis
iShares Currency Hedged MSCI Japan ETF ( HEWJ ) owns a portfolio of Japanese stocks. The fund has outperformed the S&P 500 index in the past two years. Despite its outperformance, HEWJ's valuation still appears to be inexpensive. Japan's economy also appears quite robust thanks to a resilient services sector. In addition, we do not think the Bank of Japan will reverse its dovish monetary policy due to already declining inflation. Therefore, we continue to like HEWJ and any pullback should provide good buying opportunities.
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Fund Analysis
HEWJ's return was superior to the S&P 500 index in 2023
Since we are now at the beginning of 2024, it is logical to look at how HEWJ performed in 2023. Below is a chart that compares HEWJ's price return and total return to the S&P 500 index. As can be seen from the chart below, HEWJ's total return of 35.8% was significantly higher than the S&P 500 index's total return of 25.5%. It is also worth noting that 2023 was the second consecutive year that HEWJ outperformed the S&P 500 index.
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Japan's economy is expected to remain robust in 2024
How will HEWJ perform in 2024? Will it continue to deliver positive returns than last year? In the remainder of this article, we will examine Japan's economic fundamentals, Japan's monetary policy, and its stock market valuation. Here, we will first examine Japan's economic fundamentals.
Below is a chart that shows the real GDP growth rate from 2018 to 2022 with projections up until 2028. As can be seen from the chart, Japan's GDP grew by 1.05% in 2022 and is expected to perform very well in 2023 with an estimated growth rate of nearly 2%. However, this growth rate is expected to decelerate back to 1% in 2024 due to global inflation, and decelerating global economy.
Besides Japan's decelerating GDP growth rate in 2024, Japan's composite PMI data, a forward-looking economic indicator, has weakened in the third quarter of 2023. Readers need to understand that a PMI figure above 50 implies that the economy is expected to enter expansion. In contrast, a figure below 50 shows that the economy may contract soon. As can be seen from the chart below, Japan's composite PMI reached a near-term low of 49.6 in November 2023. Fortunately, it has rebounded to 50.4 in December 2023. This low PMI figure was primarily due to global weak demand for manufacturing products. As the table below shows, Japan's manufacturing PMI weakened to 47.9 in December from 48.3 in November 2023. Fortunately, services PMI was quite resilient with a figure of 52 in December, much better than November's 50.8. Since Japan's services sectors represent nearly 70% of its GDP, we think Japan's economic activities will likely remain robust in 2024.
Will Japan tighten its monetary policy?
Japan has kept its sub-zero interest rate for many years to combat deflation. Besides low interest rates, Japan's central bank has been expanding its balance sheet by buying its government bonds and investing in ETFs. This policy will only be reversed if the inflation rate has consistently run above its long-term target of 2%. Below is a chart that shows Japan's inflation rate in the past 10 years. As can be seen from the chart below, the country's inflation rate has moved above 2% since early 2022. While some may speculate that Japan may soon reverse its dovish monetary policy, we do not think the Bank of Japan will act very soon. As can be seen from the chart, its inflation rate is now on a downward trend. It may soon fall below its 2% target towards the end of the year. If Japan reverses its monetary policy too soon, its inflation may fall even faster, and Japan may soon need to worry about deflation more than inflation. Therefore, Japan will most likely not be able to tighten its monetary policy in the near term. Its monetary policy should not be a headwind to the stock market.
Valuation is not expensive despite strong outperformance in the past few years
Now, let us examine Japan's stock market valuation. Since HEWJ has a portfolio of Japanese stocks, it will be valuable to look at Japan's stock market valuation as a whole. Here, we will use Warren Buffett's Indicator. According to Warren Buffett, it is easy to evaluate whether a country's stock market is overvalued or undervalued by looking at the total market capitalization to GDP ratio. Since Japan's central bank has expanded its balance sheets significantly over the past decades, its GDP base should also include the central bank's assets. Therefore, the revised Warren Buffett Indicator should be the ratio of the total market capitalization to (GDP + total assets of the central bank).
Let us look at the total market cap of Japan's stock market. As can be seen from the chart below, its total market cap has since increased from 300 trillion Yen to over 800 trillion Yen since 2010.
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During the same period, Japan's GDP has only grown slightly from about 500 trillion Yen to nearly 560 trillion Yen.
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Does this mean that Japan's stock market is overvalued? If we use the revised Warren Buffett Indicator and look at the total assets owned by the Bank of Japan, the answer is no. As can be seen from the chart below, the Bank of Japan's assets have also increased from about 150 trillion Yen to 750 trillion Yen.
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Therefore, the revised Warren Buffett Indicator is currently only about 64.29%. As can be seen from the chart below, this valuation is still between the valuation range of 50% and 75% in the past 10 years. Hence, we think Japan's stock market is not expensive at all. In fact, this valuation of 64.29% is much lower than the 135.8% of the U.S. market.
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Investor Takeaway
Based on our analysis, HEWJ does not appear to be expensive. In fact, its valuation is significantly lower than the U.S. market. Since we believe Japan's monetary policy will remain unchanged in 2024 due to declining inflation, we think investors can continue to own this fund and buy on any pullback.
Additional Disclosure : This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.
For further details see:
HEWJ: Not Expensive At All Despite Strong Outperformance