Small Dip In Japan ETFs Could Be Pre-Election Opportunity

Ahead of this weekend's Japanese elections that will decide control of the country's upper house of parliament, stocks in the world's third-largest economy tumbled. During Friday's Asian session, the Nikkei 225 lost almost 1.5 percent.

At this writing, USD/JPY is down almost 0.2 percent and, not surprisingly, the major Japan ETFs have followed suit. The WisdomTree Japan Hedged Equity Fund (DXJ) is off almost 1.5 percent while the rival iShares MSCI Japan ETF (EWJ) is down one percent. DXJ and EWJ are the top-two ETFs this year in terms of asset-gathering proficiency and the race for second and third is not really that close.

While those ETFs and other Japan funds look set to close the week on a down note, investors would do well to go back and look at how these funds performed after the December 2012 elections that brought Prime Minister Shinzo Abe back to power and made Abenomics a household name. Abe and his Liberal Democratic Party emerged victorious on December 16, 2012.

Past performance is never a guarantee of future returns, but there are some points worth remembering. As was the case in December, Abe's LDP is expected to cruise to a landslide victory this weekend. Following that result in December, Japan ETFs immediately responded.

From Dec. 17, 2012 through Dec. 27, 2012, DXJ and the rival db X-trackers MSCI Japan Hedged Equity Fund (DBJP) gained an average of 6.75 percent. Those gains foreshadowed not only average Japanese citizens embracing Abe and his bold economic agenda, but significant upside for U.S.-listed Japan ETFs.

Year-to-date, DBJP was sitting on a gain of almost 34 percent heading into Friday while DXJ had soared 30.1 percent.

Following the last election, EWJ, the iShares product gained 2.7 percent in the aforementioned 10-day period. The ProShares UltraShort Yen (YCS) jumped 5.3 percent and more gains for these ETFs could be on the way if the LDP emerges from the weekend's elections with a commanding upper house majority.

Wining the upper house elections is significant because Japan has suffered from deadlock in parliament ever since the LDP, led by Abe, suffered a big defeat in upper house elections in 2007, according to CNBC. An LDP victory would end Japan's hung parliament scenario, giving Abe the political capital to initiate even more bold economic reforms aimed at boosting Japan's domestic economy.

That could make a new ETF alluring for small-cap investors. The WisdomTree Japan Hedged SmallCap Equity Fund (DXJS) was not around in December, but like, DXJ, DXJS is designed to deliver upside when the yen tumbles. However, DXJS is more levered to a recovery in Japan's domestic economy, the so-called third arrow of Abenomics that could be bolstered with victory for the LDP this weekend.

Bottom line: Some investors may be concerned about the price action in Japan ETFs Friday. That does not mean the elections will not go as planned. Actually, pullback in Japan ETFs might just be a matter of profit-taking as DXJ, as one example, was up 9.6 percent in the past month heading into Friday.

BY Todd Shriber, ETF Professor