Yen Set to Weaken as G7 Avoids Currency Comments

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Markets took note of some glaring omissions after the G7 wrapped up its May meeting in Aylesbury, England.  While the finance ministers of each of the seven member nations did address the need for banking reforms and tougher crackdowns on tax evasion, little was said in the way of currency issues.  This came as a surprise to large sections of the market, as growing concerns that central bank activity is artificially guiding currency values continue to mount.  

Most of these concerns are focused on Japan, where unprecedented stimulus programs have have been announced in recent weeks.  These programs have been initiated in an attempt to weaken the Japanese yen, supporting long-term earnings prospects for export companies.  For investors holding currency positions, this creates a selling opportunity in the CurrencyShares Japanese Yen Trust (NYSEMKT: FXY), and a buying opportunity in the PowerShares DB US Dollar Index Bullish.  These two instruments track the relative values of the currencies and this strategy offers a way to play a bullish expectation in the USD/JPY currency pair.

Stimulus programs

In terms of GDP relationships, Japan’s proposed bond-buying programs will come to yearly totals of $520 billion, which is almost 10% of the country’s annual gross GDP.  The quantitative easing programs implemented by the US Federal Reserve are seen at $85 billion in bond purchases each month (or 6.8% of annual U.S. GDP).  Given the massive size and scope of the program, it is not surprising to see the Japanese yen continue to move toward new yearly lows.  This downside momentum, however, increased in speed after this month’s G7 meeting came to a close.  

Lack of currency focus

Market reactions to the G7 meeting are most clearly visible in the USD/JPY currency pair.  After the meeting (and relevant press comments from each finance minister), the USD/JPY cemented itself firmly above the closely-watched 100 level.  Passing mentions were made with respect to the recent moves seen in currency values but most of these comments were dismissed.  Instead, comments from key members nations referred the media to the G7 communique released in February, which explicitly showed that currency values are not a central focus of the G7 agenda.  

This dismissal confirmed the beliefs of yen bears, and removed all near term obstacles to selling the currency.  Thus far, the USD/JPY has reached as high as 102, which shows the yen has hit its lowest valuation levels in nearly five years.  The currency has dropped 10% relative to the dollar since the Japanese central bank announced its monetary expansion campaign in early April.  Since last November, the pair has gained nearly 30% in one of the most aggressive moves the currency market has seen since the Credit Crisis.  Now that the G7 has given the Bank of Japan implicit permission to continue with its programs, these trends are unlikely to let up any time soon.  

Investing with these trends

So, how can investors establish new positions using these trends?  The primary focus here should be on selling yen-denominated assets.  This equates to a bearish bias in ETFs that are dedicated to yen holdings.  The clearest choice here is the CurrencyShares Japanese Yen Trust, which invests in the Japanese yen and most closely tracks its value relative to the U.S. dollar.  As long as the the aggressive stimulus established by the Bank of Japan remain in place, any rallies in FXY should be viewed as a selling opportunity.  

Stock plays in Japanese exporters

When looking at Japanese export stocks, the reverse bias can be seen.  Weaker currency values make Japanese exports cheaper for foreign customers and this is likely to continue to underpin earnings prospects for some of the country’s large-cap players.  

Here, Toyota Motors (NYSE: TM) emerges as a clear beneficiary.  With a P/E of 26.1, the world’s largest automobile manufacturer is likely to outperform as a momentum play, building off of the 30% rally already seen this year. Central bank policy gives the company an edge when compared to most of its competition, so look for these rallies to continue for the rest of the year.  Year-to-date, sales growth for Toyota has already increased by 6.2% and with the latest pullback in the stock (5.9% declines from the highs), new buying opportunities can now be seen.  

Relative to its electronics counterparts in the U.S., companies like Sony (NYSE: SNE) are likely to outperform in this favorable environment.  The stock has seen substantial rallies this year, and trades with a P/E ratio of 64.7.  But looking at historical valuations, the stock remains well below its 10-year highs (above $55 per share), so there is still significant upside potential for long term investors.  

The company's latest earnings results showed that the company has returned to profitability for the first time in 10 years.  One area of strength can be seen in its Mobile Products & Communications division, which posted growth rates of 81.5%. On increased demand for its Xperia phones, this segment generated $3.5 billion in revenues for the fourth quarter of 2012.  

Forecasts for these numbers in 2013 are likely to increase, given the supportive currency environment and central bank policy.  With these stocks, investors can base positions on new policy measures, and gain the added advantage of weakening currency values.

Richard Cox has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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