Tough Time for Japan ETFs? COVID-19 Alone Isn't the Culprit

Sanghamitra Saha

Japan’s economy has been weak for quite some time now. Now, it is headed for a technical recession this year as the world’s third-largest economy shrank an annual rate of 6.3% during the last quarter of 2019. The decline was much steeper than the median market forecast of a 3.7% drop and it also marked the first slump in five quarters. The economy also saw the steepest fall in GDP since the second quarter of 2014.

The reason for the underperformance can be traced back to a tax hike (from 8% to 10%) last October, which hurt private consumption. Also, Typhoon Hagibis wreaked havoc on some parts of the country in October, hitting the economy hard.

Private consumption skidded 2.9% in the December quarter, the first period of decline in more than a year. In addition, business spending fell 3.7%, the maximum since the third quarter of 2018. Apart from the tax hike, unusually warm weather conditions largely affected sales of winter items.

The increase in sales tax in Japan and the subsequent contraction in GDP growth was observed in 1997 and 2014 as well. “The three worst quarters for household consumption in the past quarter-century were those in which sales tax was raised,” per a source.

Is Japan Headed for a Technical Recession?

Shrinkage in GDP for six months or two successive quarters or longer can be called technical recession. As Japan’s economy has been struggling hard to revive, the coronavirus outbreak has been posing threat. The virus impact is likely to push the economy into a recession in the March quarter too.

There is a big drop in Chinese tourists visiting Japan. China accounted for about 30% of all tourists visiting Japan and about 40% of the total outlays by foreign tourists last year, per an industry survey.

China is Japan’s second-biggest export destination. Not only carmakers, retailers are also eyeing China’s economy for expansion. According to a major Japan research house, Japan's GDP growth could slip 0.2% if the virus stays for a quarter, or by 0.9% if it continues for a year.

Tough Time for Japan ETFs?

The coronavirus scare has brightened the appeal for safe-haven assets like yen. Invesco CurrencyShares Japanese Yen Trust FXY is almost flat in the virus-infected past month (as of Feb 18, 2020).  With the key Japanese index Nikkei 225 being largely dependent on exports, a stronger yen goes against it. No wonder, large-cap Japanese ETF iShares MSCI Japan ETF EWJ, which has considerable exposure to foreign economies, lost about 3.1% in the past month (read: Currency ETF Winners & Losers From Coronavirus Outbreak).

With the weakening domestic scenario, stocks are getting less help from private consumption. Small-cap ETF WisdomTree Japan SmallCap Dividend ETF DFJ (which are more inclined to domestic companies)retreated 5.9% in the past month. The fund follows the WisdomTree Japan SmallCap Dividend Index, which is comprised of dividend-paying small-capitalization companies in Japan.

Having said all, we would like to note that the economy should rebound once the effect of coronavirus and tax hike phase out. The second quarter of 2020 should be a stable one for Japan’s economy. Notably, this year, Japan’s economy is expected to gain from hosting Olympics during July-August.

Thousands of sponsors, organizers, media and athletes generally visit a host city for six months before and after Olympics, which generates considerable revenues. Now it all depends on the progression of coronavirus and how it can be contained (read: Wining & Losing ETF Areas on Coronavirus Outbreak).

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Invesco CurrencyShares Japanese Yen Trust (FXY): ETF Research Reports
 
iShares MSCI Japan ETF (EWJ): ETF Research Reports
 
WisdomTree Japan SmallCap Dividend ETF (DFJ): ETF Research Reports
 
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