By Brian Manby, CFA, Principal Analyst, Research

Last month, I had the privilege of visiting the New York Stock Exchange to hear Japanese Prime Minister Fumio Kishida address investors while I was in town for the United Nations General Assembly. Japanese markets stung interest this year, driven by soaring yen weakness and the Bank of Japan’s (BOJ) commitment to accommodative monetary policy, as other central banks turn increasingly restrictive to combat record inflation.

It was a timely opportunity to hear Prime Minister Kishida’s thoughts on the yen’s 23% fall against the dollar this year and, more importantly, the role of Japan’s central bank and government in supporting it. in the future. Just hours before Kishida’s speech, Japan’s Ministry of Finance (MOF) intervened in the foreign exchange markets for the first time since 1998 to support the currency. Before the intervention, the yen traded around 145 yen per dollar and fluctuated around 141 yen soon after. A few weeks later, he gave up his earnings entirely and is currently approaching ¥150.

2022: a challenge for the yen

The support was a brief respite from prevailing headwinds for the yen, which has been challenged this year as part of the BOJ’s commitment to policy accommodation. Japanese short-term rates remain in negative territory and yield curve control has capped longer-term bond yields. Earlier this week, the BOJ conducted an emergency bond buying operation to keep yields near its policy ceiling.

Yen Bears threaten MOF

But the Prime Minister spoke of another catalyst that forced the MOF to intervene: speculative betting on the yen. Kishida asserted his belief that foreign exchange markets should determine exchange rates, but reiterated that speculation may need to be addressed, especially as it creates excessive volatility.

The Prime Minister is right. According to data from the Commodity Futures Trading Commission (CFTC), non-trading net short positions in yen futures have increased since late summer and have held steady ever since. During this period, the currency weakened by about ¥18 to the dollar.

This marked a reversal from the early summer unwinding of short positions. The most recent contract data remains deeply negative despite the September intervention. Non-commercial yen positions have also remained net short since March 2021.

Short bets kept the pressure on

But regardless of the direction of the yen or the catalysts for its movements, Prime Minister Kishida’s involvement was clear. Japan will continue to intervene appropriately to stabilize the yen in the face of what it perceives as excessive speculation and related volatility.

He is likely hoping that the threat of further intervention in the currency markets could scare off yen bears as well, although a month later the intervention had the opposite effect of stoking more volatility. Speculators continue to test the MOF’s resolve and the BOJ’s policy commitment, with the yen selling further as it nears ¥150.

Equity Implications of Yen Tug of War

Yen weakness has always been a tailwind for equities due to the export orientation of the Japanese economy, which has resulted in a negative medium to long-term correlation between Yen and market returns. scholarship holders.

Rolling 60-month correlation: MSCI Japan and yen returns

This year’s weakness resulted from traders shorting the currency due to the policy divergence between the United States and Japan, which will only widen with the Fed poised to continue raising interest rates while the BOJ remains inactive. This may give yen speculators the confidence to continue challenging the BOJ’s reactionary interventions.

However, we don’t know the frequency or magnitude of further MOF intervention, let alone where it will leave the yen in the short to medium term. Given the uncertainty amid opposing forces tug of war with the yen, we prefer a hedged approach to Japanese equity allocations, particularly with a focus on exporters.

Income diversification is key in weak yen environments

The Japanese equity market already contains a healthy mix of export-oriented companies, but seven of the 11 GICS® sectors still derive more than half of their revenue from Japan.

Geographic exposure of MSCI Japan segment revenues

Part of this is due to the nature of the sectors themselves, but in a weak yen environment for the foreseeable future, it may be beneficial to have an overweight allocation to exporters. The WisdomTree Hedged Japanese Equity Fund (DXJ) allocates to dividend-paying, export-oriented companies that derive less than 80% of their revenue from Japan, resulting in greater revenue diversification relative to the MSCI Japan Index.

Geographic exposure of revenues

By design, DXJ also tends to overweight Japan’s more export-oriented sectors while maintaining an underweight exposure to those more dependent on domestic income. For example, Materials and Consumer Discretionary are more dependent on international income than domestic income and have historically been overweight in DXJ due to its export-focused methodology.

Sector exposure at 09/30/22

Japanese yields offer a premium over bonds

My colleague Jeff Weniger wrote about stock premiums in Japan and how it is now a global outlier. Japanese equities, as represented by the underlying index of DXJ, currently offer an 11.5% yield advantage over 10-year Japanese government bonds (JGBs), due to long-term yields capped by the BOJ’s commitment to controlling the yield curve. The index is currently trading at a price/earnings multiple of less than 9, offering an earnings yield close to 12%.

Earnings yield premium over 10-year domestic bond yield

This illustrates the policy divergence with the US, which has widened over the past 10 years as the ripple effects of Fed policy changes have impacted the bond market. If the relationship were to change going forward, the compression could come from rising bond yields should the BOJ change course, but an 11.5% premium with bond yields currently close to zero is a big opportunity.

DXJ is also 100% currency hedged, completely erasing any fluctuations in the yen-dollar exchange rate, so total returns are determined solely by stock performance. More importantly, it allows investors to avoid amplifying the effects of the ongoing yen tussle in their allocations to Japan.

Important risks related to this article

There are risks associated with investing, including possible loss of capital. Investing abroad involves special risks, such as the risk of loss due to currency fluctuations or political or economic uncertainty. The Fund concentrates its investments in Japan, thereby increasing the impact of events and developments in Japan which may adversely affect performance. Currency investments involve additional special risks, such as credit risk and interest rate fluctuations. Derivative investments can be volatile and may be less liquid than other securities, and more susceptible to the effects of various economic conditions. As this Fund may have a high concentration in certain issuers, the Fund may be adversely affected by changes in such issuers. Due to this Fund’s investment strategy, it may make higher capital gains distributions than other ETFs. Dividends are not guaranteed and a company currently paying dividends may stop paying dividends at any time. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

Brian Manby, CFA, Principal Analyst, Research

Brian Manby joined WisdomTree in October 2018 as an Investment Strategy Analyst. He is responsible for assisting in the creation and analysis of WisdomTree’s model portfolios, as well as helping to support the company’s research efforts. Prior to joining WisdomTree, he worked for FactSet Research Systems, Inc. as a Principal Consultant, where he assisted clients in the creation, maintenance and support of FactSet products in the investment management workflow. Brian earned a BA with a double major in Economics and Political Science from the University of Connecticut in 2016. He holds the Chartered Financial Analyst designation.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

Commitments on the issue honored at home and abroad

Editor’s note: A survey of overseas readers of China Daily ahead of the 20th National Congress of the Communist Party of China shows that the nation’s ecological progress, economy, diplomacy, science and technology, as well as the The Belt and Road Initiative is part of the From today, China Daily will publish a series of special articles to provide readers with an in-depth look at these topics.

An intriguing cross-shaped skylight sits atop Hangzhou West Railway Station in the provincial capital of Zhejiang, giving the structure a truly modern appearance.

Covering 12,500 square meters, the skylight allows sunlight to reach a subway station under the 57-meter-tall building, significantly reducing electricity consumption needed for lighting.

Although overshadowed by the blue skylight, the black section of the complex’s huge roof has more roles to play than just keeping the wind and rain out. Composed of 7,540 photovoltaic modules, it can generate more than 2.3 million kilowatt hours of electricity per year, avoiding 2,300 tonnes of carbon dioxide emissions.

In addition, thanks to a type of high-tech material, the roof can reflect heat, which means a reduction in energy consumption for air conditioning in the complex with a total area of ​​510,000 square meters, which is equivalent to over 71 standard sized football pitches.

Designed and built with a low-carbon philosophy, the structure is an official high-level green building.

President Xi Jinping announced in September 2020 that China aims to peak carbon dioxide emissions by 2030 and achieve carbon neutrality by 2060.

At an international event in 2020, he stressed that China always honors its commitments. “We will take strong steps to implement the goals just announced and contribute even more to tackling the global climate challenge,” Xi said.

China’s actions at home and abroad show that it has kept its word.

As China moves forward with its climate goals, the public has been inundated with a relentless stream of news about the country’s climate actions.

Hangzhou West Railway Station, which opened last month, is just one of many projects making headlines as many documents are introduced at the national and regional levels to deal with the crisis. global climate.

Climate action has not only been taken in bustling urban centers such as Hangzhou, but also in the country’s vast offshore areas, sparsely populated mountainous regions and even remote deserts. Abroad, pragmatic cooperation programs have been set up to help other developing countries in their climate efforts.

Efforts welcomed

Liu Dechun, an official with the National Development and Reform Commission, or NDRC, the country’s top economic planner, said at a recent press conference: “Over the past two years, under the strong leadership of the Communist Party of China Central Committee with Comrade Xi Jinping at its heart, the country has made a good start for its dual climate goals thanks to the efforts of different regions and government agencies to pragmatically promote related work. »

China’s high-level design for these goals – dubbed the “1+N” political system – was cited by Liu as an example of such progress.

The “1” in the system refers to a main directive issued by the CPC Central Committee and the State Council, the Chinese Cabinet, as an overall guide for the goals, while the “N” refers to a series of specific action plans for different industrial sectors. sectors and accompanying policies.

Liu said, “Relevant government agencies have developed implementation plans for different sectors and industries, as well as supporting policies. Provincial-level regions have also developed their implementation plans to peak carbon dioxide emissions.

For example, one of the action plans concerns the low-carbon transition in the construction sector, which is a major emitter of carbon dioxide on a national scale. Released by the NDRC and the Ministry of Housing and Urban and Rural Development in July to achieve peak carbon dioxide emissions in the sector, the plan set out key specific targets for energy conservation and use. solar power generation installations in buildings.

According to the China Building Energy Efficiency Association, greenhouse gases emitted in the entire construction process, from material production to construction and operation, were equivalent to 4.9 billion tonnes of carbon dioxide in 2018, more than half of total emissions that year.

Energy-efficient transformations should be completed in all public buildings in major cities in China by 2030, typically increasing energy efficiency by at least 20%.

By 2025, photovoltaic panels will be installed in half of all newly constructed public buildings and factories nationwide, according to the action plan, which states that such panels will be added to more existing buildings.

China has also made efforts to harness the potential for renewable energy development in offshore areas and deserts. For example, the NDRC announced in May that the country plans to build 450 million kW of solar and wind power generation capacity in the Gobi and other desert regions.

As part of policies to support climate action, the People’s Bank of China, the country’s central bank, introduced a monetary policy tool late last year to support projects that reduce carbon dioxide emissions. . The political tool allows financial institutions to benefit from cheap loans.

China has seen robust growth in green finance over the past two years, according to the bank.

At the end of last year, the balance of green loans in domestic and foreign currencies stood at 15.9 trillion yuan ($2.24 trillion), up 33 percent from a year earlier. After a 180% increase from 2020, more than 600 billion yuan of green bonds were issued in China last year, making it the world’s second-largest green bond market.

Li Jing, climate change and sustainability services partner at Ernst & Young Greater China, said the country’s green finance market is in full swing. She expects more foreign investment in green financial products in China, such as green bonds and carbon-neutral exchange-traded funds.

Xie Zhenhua, China’s special envoy for climate change, said at a recent symposium: “The nation faces enormous challenges in achieving its climate goals, but a systematic low-carbon transition will create enormous market and investment opportunities for technological development and innovation.

He stressed that climate actions will also contribute to the synergy of efforts to strengthen the economy, employment, energy development, food production, health care and environmental preservation.

According to the Ministry of Ecology and Environment, China’s carbon emissions intensity – the amount of carbon dioxide emissions produced per unit of GDP – fell 3.8% last year. compared to 2020. “China has essentially reversed the rapid growth of its carbon dioxide emissions,” the ministry said.

The country’s hydroelectric, wind, solar and biomass capacities all rank first in the world.

In addition to climate change mitigation measures, the nation has moved towards climate adaptation.

Liu Youbin, spokesperson for the Ministry of Ecology and Environment, said: “China always attaches the same importance to climate change mitigation and adaptation by implementing a national response strategy. active in climate change”.

In June, 17 government departments, including the ministry, jointly released a new national climate change adaptation strategy. The document pledged to make significant improvements in the nation’s ability to adapt to climate change and build a climate-resilient society by 2035.

Liu said the ministry also recently issued a guideline to help provincial-level governments draft their climate adaptation plans.

Overseas measures

While promoting climate action at home, China has also announced a series of actions to shoulder its responsibility in building a global community with a shared future.

In September last year, President Xi announced that China would strengthen its support for other developing countries in promoting green and low-carbon energy, and would not build new coal-fired power projects at the stranger.

Earlier this year, in order to further promote green development under the Belt and Road Initiative, the Ministry of Ecology and Environment and the Ministry of Commerce updated a guideline of 2013 on Environmental Protection in Overseas Operations. Chinese companies were urged to adhere to environmentally friendly approaches for their projects from start to finish.

With climate change being one of the major concerns, the document includes environment-related requirements for large-scale procedures in companies’ overseas operations. For example, before overseas mergers and acquisitions, Chinese companies should assess the environmental risks caused by target companies, and greenhouse gas emissions should be prioritized in the assessment.

The directive explicitly states that priority should be given to renewable energy when Chinese companies develop energy projects.

The nation has also made consistent efforts to assist other developing countries in their climate actions through South-South cooperation.

According to the Ministry of Ecology and Environment, China has concluded 43 agreements with 38 countries in the framework of South-South climate cooperation. Besides allocating 1.2 billion yuan for such cooperation, China has provided training programs for some 2,000 civil servants and technicians working in climate-related positions in 120 countries.

On September 29, for example, China handed over to Uruguay a mobile earth system capable of receiving and processing data from meteorological satellites. The equipment is expected to improve the South American nation’s ability to deal with climate change by improving weather monitoring.

At a press conference in September, Ecology and Environment Minister Huang Runqiu stressed that China is determined to meet its climate goals. He said the goals are “a natural fit for achieving sustainable development of the Chinese nation” and “a solemn commitment to building a shared future for mankind.”

China will honor its promises with concrete actions, he said.

“While fully implementing the ‘1+N’ policy to peak carbon dioxide emissions and achieve carbon neutrality, we will actively participate in and lead global climate governance to make even greater new contributions to climate change. building a beautiful China and coping with climate change,” Huang added.