The Pullback in Japan

May 23, 2013

In light of Thursday’s 7.3% drop in the Nikkei 225, we wanted to review Japan from a trend and relative strength perspective.  Performance over the last two years is show below.  The explosive move higher in Japanese equities has been driven in large part by expectations for Prime Minister Shinzo Abe’s plan which can be summed up in his own words, “With the strength of my entire cabinet, I will implement bold monetary policy, flexible fiscal policy and a growth strategy that encourages private investment, and with these three policy pillars, achieve results.”

 

Japan

Source: Yahoo! Finance (click to enlarge)

A longer-term view of the Nikkei 225 reveals just how poor the performance for Japanese equities has been since its 1989 peak:

Japan2

Source: Yahoo! Finance (click to enlarge)

As expected from a trend following methodology, Japan also started to rise to the top of our relative strength ranks in recent months.  In fact, the iShares MSCI Japan ETF (EWJ) was added to the Arrow DWA Tactical Fund (DWTFX) in April of this year.  The strength in EWJ is just one of the reasons that DWTFX is currently outperforming 98% of its peers in the Morningstar World Allocation Category YTD.  The relative strength of Japan can also be seen in the Dorsey Wright Fund Score Rank:

fund score

 

Source: Dorsey Wright (click to enlarge)

So, let’s get to the question on everyone’s mind: What happens from here?  Will Japan bounce back and resume its explosive move higher or is it the beginning of a trend reversal?  Unfortunately, we don’t have the answer to that.  As we do with every trade, we buy strength and stay with it as long as it remains strong.  If a position weakens sufficiently in our relative strength ranks we will replace it with a stronger security.

However, I do think it is interesting to note the potential comparison to a position in China that we had in the Arrow DWA Balanced Fund from 2006 to 2008.  That transaction had a cumulative return of 103% from its initial purchase, but during the start of this magical ride there was a 21% correction.  This is documented in the chart below.

China

Source: Arrow Funds (click to enlarge)

The mere fact that Japan is back on the radar for relative strength strategies is a powerful reminder of the need to remain adaptive.  New themes are constantly developing and relative strength is adept at capitalizing on these trends.  There are plenty of pundits who are betting that Japan will continue its move higher, including Marc Faber.  This could well be a good opportunity to get exposure to DWTFX during a temporary period of weakness after the fund has climbed over 13% YTD.

Past performance is not indicative of future results.  Potential for profits is accompanied by possibility of loss.  See www.arrowfunds.com for more information.  A list of all holdings for the trailing 12 months is available upon request.

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Fund Flows

May 23, 2013

Mutual fund flow estimates are derived from data collected by The Investment Company Institute covering more than 95 percent of industry assets and are adjusted to represent industry totals.

ici 05.23.13

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