Compared to the equity markets, currency traders get very little love. Why talk about the USD/JPY trade when you can tell your friends everything you know about Apple’s (Nasdaq:AAPL) last earnings announcement? But, lately, there’s been a lot of talk about currency, especially the Yen.
The biggest currency news of the year is the continued weakening of the Japanese currency. For those unfamiliar with what is happening in Japan, here’s a primer on what could be a trading opportunity.
The struggles of Japan’s economy should hit close to home for Americans. The economy was in high gear until the mid-1990s when a stock and property bubble brought the economy to its knees. In response, the country implemented a quantitative easing (QE) program from 2001 to 2006 that fostered recovery.
Once the program wound down, the economy once again weakened. QE resumed but the massive 9.0 magnitude earthquake caused another economic emergency.
Today, the country is experiencing deflation. As a result, Shinzō Abe, Japan’s Prime Minister, is taking action. According to Dr. Steve Sjuggerud, Editor of Stansberry & Associates True Wealth and Daily Wealth, “Abe is dead-set on creating a ‘Bernanke Asset Bubble on steroids’ in Japan.”
“He will force Japanese people into stocks by cutting interest rates and printing money. Meanwhile, Japanese stocks are the cheapest they’ve been in decades.”
Why Does QE Affect the Value of the Yen?
When more money is infused into an economy, the value of the currency usually decreases. According to Rob Haworth, Senior Investment Strategist at U.S. Bank Wealth Management, “Quantitative easing will reduce real interest rates in Japan and stimulate inflation, which are typically negative for a currency.” Because Japan’s QE is estimated to be $1.4 trillion - 60% larger than the United States’ QE - expect continued pressure on the Yen.
But there’s another force at work. Abe expects that QE will continue to devalue the currency and that will effectively put all Japanese exports on sale to other countries. But as other countries race to devalue their currency, who will win in the end?
David Houle, Certified Financial Analyst with Season Investments says, “The weakening Yen makes Japan's goods cheaper for foreign buyers, thus making Japanese manufacturers more competitive and fueling export growth.”
“However, it also makes foreign imports more expensive, which may have a negative impact on key trading partners. This is why the term ‘currency wars’ has been used to describe the various stimulus programs being implemented by global central banks.”
What is the Outlook Going Forward?
If QE works as expected, the Yen should continue to weaken. Keith Raphael, President of Crosscurrents Investment Advisory says, “We continue to forecast the further rally to 101.45 in June 2013 and 118.80 through March 2014. What this means to the average investor is that there is a further decline of approximately 20% coming over the next year … and the Japanese government will promote that decline,” because the yen is/was quite strong.
But Bloomberg reports that as Japan gets what it wished for, it might be getting a little nervous about the meteoric drop. Koichi Hamada, one of Abe’s advisers, recently said that the government was working hard to influence the yen but, “if it goes too far, it should be stopped.” He said that if it reached 110 against the dollar that would be too weak.
Why the government suddenly got a little skittish is unclear but as the yen weakens, U.S. industry groups are starting to use the m-word again: manipulation. An industry group representing the Big Three automakers recently called on President Obama to retaliate against the move.
How can investor play the weakening yen? Forex traders can, of course, trade the USD/JPY, but what about equity traders? First, if you believe that Japanese QE will raise demand for Japanese exports, invest in Japan-based companies.
Examples include Honda Motor (NYSE:HON), Sony (NYSE:SNE) and Toyota Motor (NYSE:TM). Committing money to a stock for the sole reason of capitalizing on the improving economy isn’t advised, but if your research finds these or other companies to have strong balance sheets and attractive risk/reward profiles, think of the currency argument as one more bullish reason to invest.
The other way is through ETFs. In January, Sjuggerud recommended the WisdomTree Japan Hedged Equity Fund (ARCA:DXJ). Since that time, it’s up more than 25%. The fund’s top holdings include Honda, Toyota and Canon (NYSE:CAJ). The fund invests in stocks while hedging against currency risk. In other words, you get the upside that companies see from a weakening yen without the currency effect going against your trade.