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Michael Gayed: Why Japan Bulls Will Move to Emerging Markets


If bulls like Japan because the yen-depreciation story was so powerful, then they should be enamored with emerging markets.

The story being written in Japan is a fascinating one. Abenomics has resulted in a ton of optimism over a final end to decades of deflationary overhang. The Nikkei (INDEXNIKKEI:NI225) surged in 2013, and many are arguing we are in the midst of a "healthy pullback."  Maybe this is true.  After all, following huge moves higher, stocks tend to decline or at least consolidate to take a breather.  However, this is largely predicated on the idea that unprecedented monetary stimulus by the Bank of Japan will continue to push the yen lower, increasing exports as foreign buyers get attractive to cheaper yen-denominated goods.
But what if the yen actually strengthens because the people on the ground simply can't handle the rising cost of imported goods, which Japan is so reliant upon?  If bulls like Japan because the yen-depreciation story was so powerful, then they should be enamored with emerging markets, which, like Japan, are broadly dependent upon exports. Take a look below at the price ratio of the Japanese Yen ETF (NYSEARCA:FXY) relative to the Wisdom Tree Dreyfus Emerging Market Currencies Fund (NYSEARCA:CEW). As a reminder, a rising price ratio means the numerator/FXY is outperforming (up more/down less) the denominator/CEW.

The yen, relative to emerging market currencies, has gone sideways for nearly a year now, and it may be poised to break out higher. This means that the yen may end up outperforming emerging market currencies. If you like the idea of buying countries that have weakening currencies relative to other exporters, then emerging markets -- and not Japan -- is the bet to make.  This would be healthy given that buyers may end up viewing Japan's exports as comparatively more expensive over time, pushing money into those countries that many assume will never rally again.
Bullish Japan and not emerging markets? Inconsistent idea. Take a look at the price ratio of the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) relative to the iShares Japan ETF (NYSEARCA:EWJ). 

I'm pretty sure Abe's arrows aren't enough.

Twitter: @pensionpartners
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