Japan ETFs Pop As Election Nears; Yen Falls

On another down day for U.S. equities, a surprising group of ETFs were noticeably higher: Japan ETFs. With the world's third-largest economy likely to hold elections next month, traders are speculating that Shinzo Abe, head of the main opposition Liberal Democratic Party, will become the country's next prime minister.

Abe, himself a former prime minister, has talked the talked when it comes to suppressing the yen. When it comes to quantitative easing, Abe appears to have graduated from the Ben Bernanke School of Easing because Abe has told the Bank of Japan to engage in unlimited easing in an effort to reflate the Japanese economy.

Whether or not BoJ does that and whether or not Abe wins are other matters altogether. For now at least, traders like what they hear hand have sent the ProShares UltraShort Yen (YCS) up by more than 2.2 percent on volume that is already close to being 50 percent above the daily average. Japanese exporters prefer a weaker yen because it makes exports cheaper in international markets while boosting income earned in foreign markets.

Abe has also said BoJ should engage in a sub-zero interest rate policy to spur growth in the Japanese economy. Earlier this week, Japan said its third-quarter GDP contracted by 3.5 percent, the worst drop since the earthquake and tsunami ravaged the country in March 2011.

Still, Japan ETFs are showing some temerity today. The iShares MSCI Japan Index Fund (EWJ), the largest Japan-specific ETF by assets, is higher by 1.5 percent. Even the thinly traded SPDR Russell/Nomura Small Cap Japan ETF (JSC) is getting in on the act with a gain of almost 0.7 percent.

Prime Minister Yoshihiko Noda is expected to dissolve parliament Friday with an eye toward holding elections in a month. One reason why traders are bidding up Japanese equities and punishing the yen today is that polls show Abe will handily defeat Noda.

While Japan is usually viewed as politically stable nation, the view of some outsiders is that BoJ has run out of policy weapons with which to suppress the yen and reflate an economy that has been savaged by deflation for the better part of two decades.

Investors looking for Japan exposure while holding a hedge on the dollar/yen trade should consider the WisdomTree Japan Hedged Equity Fund (DXJ).

Earlier this week, it was announced DXJ's index, the "the WisdomTree Japan Hedged Equity Index will be adding a geographic revenue filter to remove companies that derive the bulk of their revenue from Japan. As a result, the WisdomTree Japan Hedged Equity Index will allocate more weight and exposure to Japan-based multinational companies that we believe stand to benefit more from a weakening yen relative to the U.S. dollar," WisdomTree Research Director Jeremy Schwartz said in a research note.

By focusing on Japanese firms that are less dependent on their home nation for the bulk of their revenue, the ETF becomes less vulnerable to yen strength. DXJ's new lineup could also sport a negative correlation to the yen over all relevant time periods, providing investors with the desired hedge effect.

By The ETF Professor