FMD Capital Management

Japan Currency Trade Hits A Stumbling Block

Written by David Fabian, June 05th, 2013

One of the hottest ETFs of the year has been the WisdomTree Japan Hedged Currency ETF (DXJ) which hit an intra-day high in May and has since fallen nearly 18% over the last 10 trading sessions.  Prior to this sell off, DXJ had posted gains of over 46% in 2013 which put it in the top 1% of ETF performers this year.  According to Index Universe, DXJ is the top gatherer of new assets this year with investor pouring over $7.6 billion of new money into this surging economy.

As you can see on the chart below, DXJ has fallen below its 50-day moving average and appears poised to continue its recent descent.  At times like these I am reminded of the adage, “the bigger they are, they harder they fall” which appears to be the case with DXJ as early investors are more than likely taking profits and standing aside at this juncture.

This WisdomTree fund differentiates itself from the widely held iShares Japan ETF (EWJ) by carrying an additional currency component that hedges its exposure to the Japanese yen.  Put simply, DXJ will outperform EWJ when the yen is falling in value vs. rival foreign currencies.  Looking a chart of the CurrencyShares Japanese Yen Trust (FXY), you can see that the yen has recently regained momentum which will act as a headwind for DXJ.

If this yen continues this recent ascent and the Nikkei 225 index continues to fall, DXJ will find itself fighting two separate forces which may exacerbate the selloff.  Ultimately this decline will be healthy in the sense that these stocks can work off some of their overbought momentum and allow new investors the opportunity to purchase this ETF on a pullback.

The real question is whether or not the aggressive quantitative easing measures implemented by Shinzo Abe, the current Prime Minister of Japan, will continue to stimulate Japanese stocks and devalue their currency.  So far the experiment has produced positive results, however the recent sell off is the first real test of investors’ resolve.

In addition, because Japanese stocks have been a leader on the upside all year long, domestic markets may ultimately take their cue from the land of the rising sun.  The S&P 500 Index has started to see its first real signs of weakness in 2013 that can be attributed to weaker economic data at home as well as global stock declines.

I still believe that DXJ is a unique investment opportunity for playing the Japanese stock market, however I am cautious about entering this position until we have seen some stability return.  It’s always advantageous to purchase a position on a pullback in price, but I never try to catch a falling knife.  Traders that are looking to make an entry into this sector may look to use the 50-day moving average as an upside target on DXJ if it can regain those levels.  Remember that with a high beta position like DXJ that you should always implement a risk management strategy such as a stop loss to guard against an even more protracted decline.