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A stronger-than-expected jobs report last Friday firmed expectations that the Fed may raise rates in December. However, the Fed has made it very clear that even after the first hike, the monetary policy is going to stay accommodative for quite some time. While a recovering economy and still accommodative monetary policy are good for US stocks, many investors are worried about rich valuations in the face of lackluster earnings. Investors should consider adding some Japanese stocks and ETFs to their portfolios, considering expectations of additional stimulus, rising corporate profitability and still-attractive valuations. Stimulus Expectations Rising In its last meeting, the Bank of Japan decided to keep its powder dry and maintained QE at the current level of ¥80 trillion ($660 billion) annually. However, taking into account the impact of the emerging markets’ slowdown, the bank downgraded its growth projections. Many still expect that the BOJ will have to announce an increase in asset purchases in the coming months. If the central bank decides to keep the stimulus unchanged, despite weak economic outlook, it will likely to be perceived as an acceptance by BOJ of its inability to ward off deflation. The BOJ governor reiterated its resolve to take further policy action if needed, and the case for additional easing continues to strengthen. Is Abenomics Working? The headline consumer prices index had risen after the launch of Abenomics in 2013, but has fallen back to zero, thanks mainly to the collapse in oil prices. Sales tax hike last year also forced consumers to cut spending and pushed inflation lower. The BOJ has now extended the deadline for achieving inflation target of 2% by six months. On the other hand, a new index of inflation, which excludes energy and food, has been rising; it was up 1.1% in August and 1.2% in September. The labor market has tightened, with the unemployment rate plunging to 3.4%. And the stock market is up about 120% since the launch of Abenomics (in local currency terms), thanks mainly to a surge in corporate profits, while the yen has declined almost 30%. Nominal GDP has actually turned upwards since 2013, after 20 years of sideways movement. Higher-than-expected industrial output (1.0% versus 0.5%) has also eased worries regarding a recession during the third quarter. Can the Yen Weaken Further? After falling to a 13-year low in June this year, the yen had rebounded nicely, thanks mainly to its safe haven status amid global turmoil. The currency has weakened over the past few weeks as expectations of the rate rise by the Fed have been rising. Rising Earnings; Increasing Shareholder Value Thanks mainly to the declining yen, Japanese companies’ earnings have improved a lot since the launch of Abenomics. The outlook for earnings growth for Japanese companies, particularly exporters, remains much better than in the US, with rising expectations for a rate hike by the Fed in December. Further, Japanese authorities have been encouraging companies to improve corporate governance and increase shareholder value via dividends and buybacks. Japanese Stocks Are Still Attractively Valued Despite recent rise, Japanese stocks trade at cyclically adjusted price/earnings ratio (CAPE) or Shiller P/E of 26.4 more than 20% below than the historical average of 34.4. Considering superior earnings growth potential of Japanese companies, these valuations look very attractive. Japan Post’s Strong IPO Japan Post, the parent and its banking and insurance units, IPO’d successfully last week on the Tokyo Stock Exchange. It was the largest IPO since Alibaba’s (NYSE: BABA ) public debut last year. The demand was very strong, the IPO oversubscribed and the shares opened 16.5% higher than the IPO price. The institution manages almost 25% of Japanese savings, and phased freedom from state ownership helps it to take more risks. So far, most of Japan Post’s assets have been invested in safe government bonds. Japanese authorities are trying to encourage investors to put more money into stocks rather than in savings products. The 144-year old Japan Post has a well established brand and is expected to attract retail investors. Biggest Risk for Japanese Stocks: China Slowdown Japan’s exports to China fell 3.5% last month, after declining 4.6% in August. With a slowdown in Chinese demand, Japanese exporters are cutting their production and profit forecasts. A decline in profits would further hurt investments and wages. A sharper slowdown in China could present the biggest challenge to Japanese equities; however, recent data suggests that China’s growth panic is probably overdone. Best ETFs to Consider In view of the reasons discussed above, we strongly believe that investors should consider investing in currency hedged Japan ETFs, which offer an excellent way to profit from the rise in Japanese stocks, while hedging the currency risk in case the yen moves lower. Additionally, adding some international flavor to the portfolio provides diversification benefits and boosts long-term risk-adjusted returns. The WisdomTree Japan Hedged Equity ETF (NYSEARCA: DXJ ) is the most popular ETF in this space, with $16.9 billion in AUM. The fund’s top holdings include well known Japanese companies Toyota (NYSE: TM ), Mitsubishi ( OTCPK:MMTOF ), Japan Tobacco ( OTCPK:JAPAF ) and Canon (NYSE: CAJ ). It charges an expense ratio of 0.48%. DXJ is up more than 12% year to date. Another great ETF worth a look is the Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEARCA: DBJP ), which follows a similar strategy and is also slightly cheaper, with an expense ratio of 0.45%. Toyota, Mitsubishi and Softbank ( OTCPK:SFTBY ) are among its top holdings. DBJP is up almost 13% this year. The iShares Currency Hedged MSCI Japan ETF (NYSEARCA: HEWJ ) provides exposure to large- and mid-capitalization Japanese equities, both exporters and local companies. The fund’s expense ratio is 0.48%. The product is basically a currency hedged version of the ultra-popular Japan ETF EWJ. It is up more than 13% this year. The WisdomTree Japan Hedged SmallCap Equity ETF (NASDAQ: DXJS ) provides access to the small-cap segment of the Japanese stock market, while hedging the currency exposure. It charges 58 bps in expenses per annum. Smaller companies are more sensitive to domestic economic trends than their larger-cap counterparts, but at the same time, their stock prices are more volatile. This product has returned almost 18% this year. The WisdomTree Japan Hedged Financials ETF (NYSEARCA: DXJF ) provides currency hedged exposure to the financial segment of the Japanese stock market, including banks and insurers. It charges 48 bps in expenses. Financial firms have been benefitting from the rising stock market, and the ETF is up more than 18% this year. Original Post