Be careful with Japan-heavy ETFs

Investors should take the country's recent GDP gains with a grain of salt.

By TheStreet Staff Dec 10, 2010 1:41PM

more ETF investing strategy from thestreetglobal economy © Comstock / SuperStockBy Kevin Grewal, TheStreet

 

Japan recently witnessed its fourth consecutive quarter of economic growth, enabling it to reclaim from China its position as the world's second-largest economy after beating gross domestic product expectations.

 

That growth could affect the iShares MSCI Japan Index (EWJ), the iShares MSCI Japan Small Cap Index Fund (SCJ) and the Vanguard Pacific Stock ETF (VPL).

 

The Japanese economy expanded by 4.5% in the third quarter of the year, exceeding analysts' expectations by 0.6% and eating away at the nation's massive deflationary gap. Further, the expansion has led to Japan's minister of economic and fiscal policy to peg an estimated annual growth for the year at around 2.6%.

 

Although Japan has been exceeding growth expectations, it is important to take this outperformance with a grain of salt. The nation's economic growth was driven primarily by increases in private-sector inventories, suggesting that now that inventories have been replenished, production cuts are likely to prevail.

Another driver behind GDP growth was an increase in domestic consumption driven by deadlines for subsidies for environmentally friendly vehicles and other economy-boosting measures, which are expected to expire and have a negative effect on future consumption.

 

In fact, these trends are already starting to prevail as unemployment rates have started to worsen, industrial output has started to decline, retail spending has started to taper off and exports have slowed.

 

Further straining Japan's economic outlook, corporations are starting to practice more caution with regard to investing, and policymakers are hinting at increasing the consumption tax rate to procure money for the nation's aging population.

 

At the end of the day, when it comes to economic growth, Japan faces an uphill battle and is likely to lose its place as the world's second-largest economy sooner rather than later.

  • iShares MSCI Japan Index allocates nearly 19% of its assets to the consumer discretionary sector.
  • iShares MSCI Japan Small Cap Index Fund allocates nearly 20.75% of its assets to consumer discretionary and is more correlated to consumer sentiment in Japan than ETFs that track and hold large-cap stocks.
  • Vanguard Pacific Stock ETF allocates more than 60% of its assets to Japan.

 Grewal has no positions in the funds mentioned.

 

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