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Tuesday's most active stocks included: Time Warner (NYSE: TMX), Nortel Networks (NYSE: NT), General Electric (NYSE: GE), Lucent Technologies (NYSE: L), Pfizer ( NYSE: PFE), iShares Japan Index Fund (AMEX: EWJ), iShare Russell 2000 Index (AMEX: IWM), and Energy Select SPDR ( AMEX: XLE).
Deflation, recessions, and a troubled banking industry kept pulling Japan back down. By early 2003, the Nikkei 225 Index remained 80% below its 1989 high, and the country’s GDP was in its 12th year of averaging 1% annual growth. That’s when things started to change for the better, with an upswing that has many investors seeing a long-awaited, long-term recovery.
Japan’s GDP grew in each of the last four quarters, hitting 5.4% for the fourth quarter of 2005. Meanwhile, corporate restructuring, government reform, and stronger consumer spending fueled higher profits, pushing Japan’s stock prices skyward. iShares MCSI Japan returned 38% in the year ended April 13, and now sports a three-year, annualized return of 32.4%. EWJ gained 5.3% over the last month, and tore its way up the International Rankings Table, from 28th on March 7 to fourth last week.
The fund tracks its namesake index, which usually holds close to 350 stocks and attempts to capture 85% of the country’s total market cap. EWJ uses a representative sample of stocks, recently 281, heavily weighted toward the country’s biggest companies.
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As the economy recovered, consumer prices rose, exports picked up, and companies invested in new equipment and facilities. All that drew the world’s attention and made EWJ and other Japanese stock funds wildly popular to American investors.
The fund is one of the most actively traded ETFs of them all, with an average volume of nearly 25 million shares. In recent weeks, EWJ often placed on the NYSE’s list of most active stocks.
The influx of foreign money likely helped the recovery. Indeed, investors are flocking in: In 2005, Japan stock funds saw net inflows of about $8.2 billion, according to Financial Resource Corp. More than half, or $4.2 billion, went to EWJ, which took in $3.1 billion in 2004 and now has about $14.6 billion in assets.
At the same time, Japanese firms boosted profits through cost-cutting and other restructuring, including taking advantage of labor reforms that have lifted wages, usually a good sign for consumer spending.
The fund’s model is working. All of EWJ’s top 10 holdings saw share prices increase at least 40% in the last year, led by the financial sector, which accounted for more than 18% of the fund’s assets at the end of March.
Shares of the fund’s largest banking and brokerage companies, which include four of the fund’s top 10 holdings—Mitsubishi UFJ Financial Group, Mizuho Financial Group, Sumitomo Mitsui Financial Group, and Nomura Holdings—averaged 95.4% gains in the year ended April 14.
All benefited from government reforms, which helped banks pare down massive amounts of bad debt and gave the industry more solid footing. A five-year policy of near-zero interest rates helped, too.
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Capital goods (11.2% of holdings) and automobiles and components (10.6%) are the fund’s next-largest sectors. Top holdings include many recognizable names, that have improved profit margins through restructuring and moving manufacturing to less expensive labor markets outside the country. Toyota, with a 12-month return of 75.1%, Canon (48.4%), and Honda (45.9%) all fit that bill.
Two upcoming events could affect the growth trend. First, many analysts expect the Bank of Japan to shift away from its low interest-rate policy in the coming months. Lifting rates could require a delicate balance. Second, Japan Post, the government-owned postal service that runs savings accounts and insurance policies with assets of more than $3 trillion, appears to be on the route to privatization. Shifting that money to financial markets could provide an added boost to the recovery.
EWJ represents a bet on that recovery and further growth, and many investors see great potential. Measured by the Nikkei Index, the market remains about 60% below its high of 17 years ago.
A key thing to remember, however: Japanese stocks rallied several times over the past 10 years, and each time they slid back. EWJ has seen some wild swings, including a 30% drops in 2000 and 2001, and some analysts see potential threats to exports through a strong run by the yen or a slowdown overseas, particularly in the U.S. or China. Potential investors should keep those historical risks in mind, and keep EWJ as a niche player in their portfolios.
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Performance:
EWJ (NAV) vs. Category*
YTD** +6.4 -0.4 2005 +24.7 +0.2
2004 +14.8 +0.6
2003 +35.5 +1.4
2002 -10.5 -0.1
*Category: Japan Stock
**Through 3/31/2006
Source: Morningstar
Top Ten Holdings as of March 31, 2006
Toyota Motor Corp. 5.57%
Mitsubishi UFJ Financial Group 4.61%
Mizuho Financial Group 2.75%
Sumitomo Mitsui Financial Group 2.30%
Takeda Pharmaceutical 1.78%
Canon 1.76%
Honda Motor 1.72%
Sony 1.66%
Matsushita Electric Industrial 1.55%
Nomura Holdings 1.37%
Source: iShares.com
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