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Is Shorting the Yen Still a Sure Thing?

Most small-time American investors don’t dabble much in currencies or the machinations of governments and central banks halfway around the world.

But maybe they should.

You see, one of the biggest trades of the last several weeks has been shorting the Japanese yen. Here’s what went down in Japan recently that made the trade so attractive — and profitable — for many investors:

  • LDP Power Grab: A landslide win for former Japanese prime minister Shinzo Abe and his conservative LDP party across parliament means a mandate for more aggressive policy to boost the economy via stimulus and central bank policy.
  • More Loose Than the Fed: The Bank of Japan is set to outpace the Federal Reserve in quantitative easing — known by some as “printing money” — in 2013.
  • Big Trade Deficit: Japanese exports in November were better than expected, but still down 4.1% year-over-year. The trade deficit jumped to almost 1 trillion yen, or $11 billion, to mark the third-largest on record. It also marked the fifth straight month of shortfalls, the longest run of deficits since 1980. The balance of trade also has weighed on the yen as Japan sends more capital overseas lately.
  • Stimulus Rumblings: Pair the political momentum of Mr. Abe with continued struggles like this trade deficit, and there’s serious talk of a big stimulus in Japan to boost the economy. Stocks are rallying as a result, and the yen has weakened at the prospect of a government handout that could top 10 trillion yen, or $110 billion.

There are other headlines, but these are big ones and should explain why so many people are shorting the yen. It’s logical: A landslide election puts power in the hands of those who want to spend more and loosen central bank policies amid a weak economy. It means Japanese stocks are going up and the yen is going down.

Take a look at this chart and see how the trade has worked out.

Is it any wonder that big-time hedge funds have piled into the short yen trade?

In early December, Jeff Gundlach called attention to the pair trade where you go long Japanese stocks and short the Japanese yen — and he has done quite well. Other big-time traders have gotten in on the act too, and the MarketBeat blog at the Wall Street Journal even postulated before the New Year that the short yen trade was already so popular it “could be hedge funds’ favorite trade in 2013.”

How You Can Play the Yen Trade

Now let’s admit that monkeying with currencies is impractical for many retail investors, and it’s unfair to think we all have the same tools at our disposal that hedge funds do.

But if you believe this trade will last — and given the open-ended nature of Japan’s easing and the early days of stimulus talk, there’s a chance it will — there are a few ways you can play the short yen/long Japan stocks trade if you choose:

  • If you can short securities, take a downside bet on the CurrencyShares Japanese Yen Trust ETF (NYSE:FXY). Or if you trade options, buy puts on the FXY if you don’t want to go short. The FXY has lost about 9% since Nov. 1.
  • There’s also a way to go long Japan stocks via ETFs. The iShares MSCI Japan Index Fund (NYSE:EWJ) is most common, with assets of more than $5 billion. The EWJ fund is up about 8% since November.
  • A more sophisticated fund would be the WisdomTree Japan Hedged Equity Fund (NYSE:DXJ). The fund is meant to keep investors long in Japanese stocks while hedging against a weak currency — the perfect play for this environment (while it lasts). The DXJ is up about 18% since November.
  • And last but not least, you can always bet on Japanese companies that could benefit from a weak currency by boosting exports. Toyota (NYSE:TM) is one example, and the stock is up over 24% since Nov. 1.

Just remember to do your research on the fundamentals and valuation of these companies, however, because macroeconomics alone can’t save a poorly run company.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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