Japan failed to sustain the winning momentum from Abenomics. But the country’s stock market has strongly rebounded in recent months. This is especially true, as the Nikkei Stock Average, targeting Japanese stocks, rallied more than 14% from the lows reached in April to an eight-month high.

The rekindled interest was mainly driven by the fact that Japan is reallocating most of the $1.2 trillion public pension fund into riskier assets like equities and out of low-yielding Japanese government bonds. The Government Pension Investment Fund plans to increase the weighting of domestic stocks to more than 20% from the current 12% target (read: Introductory Guide to Japan ETF Investing).

This will likely spur investments and growth in the economy, which is currently struggling from a sales tax hike in April. The economy shrank 7.1% annually in the second quarter, marking the worst decline since the first quarter of 2009 and spreading fears over the viability of ‘Abenomics” – a stimulus program introduced by the Prime Minister Shinzo Abe last year to lift the world’s third largest economy out of feeble growth and deflationary pressure.   

The impressive stock performances also came on the back of improving domestic demand, record Japanese corporate profits since the 2008 global financial crisis and the upbeat stock market prediction for the upcoming quarters. In addition, the sliding Japanese yen, currently at a six-year low, is benefiting exporters and the manufacturing industry, resulting in soaring stock prices. This is because Japan is primarily an export-oriented economy and a weaker currency makes the country’s exports more competitive.

The diverging central bank policies by the U.S. and Japan would continue to soften the yen in the coming months. The U.S. dollar will continue to strengthen on a brighter economic outlook, which has raised hopes for a sooner-than-expected rise in interest rates while the slowdown in Japanese economy has fueled optimism for further monetary easing (read: 3 Excellent ETFs to Play the Dollar Surge).

Further, the heavy sell-off in the Japanese stocks early in the year made valuations compelling at current levels, advising investors to cash in on the beaten down prices given the slowly improving fundamentals. Fortunately, there are just a few top ranked picks in this corner of the world, and we have described them below. Any of these could enjoy smooth trading and lead the market higher in Q4:  

Top Japan ETFs:    

WisdomTree Japan Hedged Equity Fund ((DXJ - ETF report))

This is by far the largest and popular Japan ETF with AUM of $10.5 billion and average daily volume of more than 3.9 million shares per day. The fund offers exposure to Japanese stocks while at the same time provides hedge against any fall in the Japanese yen. This is easily done by tracking the WisdomTree Japan Hedged Equity Index. The fund charges 48 bps in fees per year from investors.

Holding 309 stocks in its basket, the product is slightly concentrated on the top two firms – Toyota Motor and Mitsubishi – with 5% share each. Other firms do not hold more than 3.80% of assets. Consumer discretionary and industrials take the top two spots with 24.8% and 22.7% share, respectively, while information technology and financials round off the top four. The ETF added just 2.5% so far in the year and has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a Medium risk outlook.

db X-trackers MSCI Japan Hedged Equity ((DBJP - ETF report))

This product tracks the MSCI Japan US Dollar Hedged Index, which provides exposure to Japanese equity markets and hedges the Japanese yen to the U.S. dollar by selling Japanese yen forwards. The fund holds 313 securities in its basket with largest allocation going to Toyota Motor while other firms make up for less than 2.9% of assets.

From a sector look, the ETF is bit concentrated on consumer discretionary, industrials and financials that collectively account for more than three-fifths share in the basket. The fund has amassed $55.8 million in its asset base and charges 45 bps in annual fees. Volume is good as it exchanges about 109,000 shares per day. DBJP is down 0.3% in the year-to-date time frame and has a Zacks ETF Rank of 2 or ‘Buy’ rating with Medium risk outlook (read: Inside The Top Ranked Japan Hedged Equity ETF).

Top Japan Stocks:

Mizuho Financial Group ((MFG - Snapshot Report))

Investors looking for a concentrated play in this Asia-Pacific country will find the only top ranked MFG an intriguing pick. This company provides various banking and financial services in Japan including deposits, housing loans, investment trusts and individual insurance products. It also manages trust products as an agent, retail banking solutions consisting of consulting services of business succession and asset inheritance, and asset management for both business owners and high-net-worth customers.

Mizuho Financial is down 12.3% in the year-to-date time frame but has a Zacks Rank #2 (Buy), suggesting that it will outperform in the coming months and that the beaten down prices could be the perfect entry point. Additionally, P/E ratio comes in at 8.59 compared to 17.10 for the broad market index and 12.90 for the industry, underscoring that it is extremely cheap at current levels (see: all Developed Asia-Pacific ETFs here).

Bottom Line

Despite the current slowdown, Abenomics and a weaker currency are expected to drive growth and exports in the economy. Japan’s economic conditions are still stronger relative to other developed countries, compelling investors to play in this market and take advantage of the beaten down prices.

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