Japan Delays Tax Hike: Small-Cap ETFs To Play

As widely expected, Japan’s prime minister has postponed a planned hike in sales tax until 2019. Many have seen this move as a backtracking stance by the country’s prime minister Shinzo Abe. However, there were probably no alternatives apart from delaying the tax hike as the Japanese economy has cooled lately.

How Harmful Previous Tax Hike Was?

The economy showed signs of a recovery in 2013 after Shinzo Abe introduced 'Abenomics' – a monetary and fiscal firepower to fight longstanding deflation and feeble growth. But the momentum fizzled out in 2014 with its economy slipping into a technical recession in Q2 and Q3 on a hike in the consumer tax rate from 5% to 8% in April along with weak wage growth that wreaked havoc on consumer spending.

Since then, the country couldn’t enact another hike from 8% to 10% as the economy was threatened by recession on and off. In Q1 of 2016, the economy grew 0.4% following 0.4% shrinkage in Q4 of 2015, 0.3% advancement in Q3 of 2015, 0.3% contraction in Q2 of 2015 and 1% growth in Q1 of 2015. From this, one can easily understand how hard it was for the Japanese economy to stay on a stable growth path (read: IMF Cuts GDP Outlook for Japan; ETFs in Trouble?).
Japan is facing serious threats of deflation despite Bank of Japan’s (BoJ) gigantic stimulus program and the launch of negative interest rates in January.

Consumer prices in Japan dropped 0.3% year over year in April 2016 followed by a 0.1% decline in March. Notably, the decline in March was the first decline since May 2013.

At first, this tax jump from 8% to 10% was targeted in October 2015. But it was then postponed to April 2017 due to severe economic conditions before the latest delay. Apart from economic issues, an upper house election scheduled for July 10, may have stopped Abe from being too aggressive.

Inside the Recent Abe Move

Abe held the slowdown in emerging nations like China responsible for his latest move. He also emphasized that he would adopt more steps to boost the economy later this year.

Notably, the tax delay move would pose threats to Japan’s debt market, the size of which is the largest in the developed world in stark comparison to the size of its economy. The tax increases were targeted to attain a primary government budget surplus. But this delay blurs the budget surplus goal, as per analysts.

ETFs to Benefit

Definitely easy fiscal and monetary policies would spur domestic consumption and have a positive impact on stocks that are tied closely to the domestic economy. Stocks tied to the export sector are less likely to avail the benefit of the tax hike delay amid a stronger yen.

Notably, CurrencyShares Japanese Yen ETF (NYSE:FXY) (FXY) – which reflects the price of the Japanese yen in USD – added over 12.9% in the last one year (as of June 1, 2016). As yen strengthened, Japan’s large-cap ETF iShares MSCI Japan (EWJ) shed 10.3% in the last one year (as of June 1, 2016) (read: What Lies Ahead for Yen ETF after G-7 Meet?).

Since small-cap stocks are largely related to the domestic economy, below we highlight three small-cap ETFs for potential gains (read: 4 Small-Cap ETFs for a Bumpy Japan Ride).

WisdomTree Japan SmallCap Dividend Fund (DFJ)

This fund targets the dividend paying small cap stocks, which is a win-win combination as the lure for dividends should be higher in Japan given the rock-bottom interest rate level.

This $409.1-million fund is heavy on industrials (25.1%), consumer discretionary (23%) and materials (12.7%). Holding 593 securities in its basket, it has a spread out exposure to various components as each firm holds less than 0.92% of total assets. It charges an annual fee of 58 bps.

iShares MSCI Japan Small-Cap ETF (SCJ)

This $170.1-million fund is widely spread out across stocks. However, about one-fourth of the portfolio is allotted to industrials, closely followed by consumer discretionary (18%) and consumer staples (12%).

SPDR Russell/Nomura Small CapTM Japan ETF (JSC)

The fund looks to track the Russell/Nomura Small Cap Index. The $52.8-million fund charges investors 40 bps in annual fees. In total, the fund holds well-diversified 730 securities in its basket with none accounting for more than 0.47% of assets. Here again, industrials make up for the top sector at 26.1%, closely followed by consumer discretionary (20.9%).


WISDMTR-JP SC D (DFJ): ETF Research Reports

ISHARS-MS JA SC (SCJ): ETF Research Reports

SPDR-RN SC JAP (JSC): ETF Research Reports

CRYSHS-JAP YEN (FXY): ETF Research Reports

ISHARS-JAPAN (EWJ): ETF Research Reports

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