Major Japanese Stock Indices closed lower for the 6th consecutive trading day Tuesday in Tokyo. The Nikkei 225 Stock Average fell 328.49 yen (-1.99%) to finish at 16,158.42 for its lowest close since March 16th. Find out why Japanese ADRs and ETFs have been holding their ground and how to better understand investing in Japan.

Investors in Japanese ETFs such as iShares MSCI Japan Index ETF (EWJ) have been somewhat shielded from the Nikkei's recent tumble since the yen has strengthened against the dollar to its highest level in about seven months.

In order to see the impact of foreign exchange rates, let's compare the market price of EWJ on March 16th to where it closed yesterday and then check back and see where it closes today. Some investors watch the N225 for guidance as to how EWJ will trade but don't understand that EWJ tracks the MSCI Japan Index and not the N225, although the N225 makes up about 80% of MSCI Japan. Also, don't forget to keep an eye on the Yen/USD exchange rate. I do want to use this comparison for illustrative purposes and because the final May 16th MSCI Japan Index data hasn't been published yet. Remember we're using March 16th since that's the last time the Nikkei 225 closed as low as it did today.

May 16th N225: 16,158.42
May 16th EWJ: ______
May 16th Yen/USD: approx. Y110.25/US$1
March 16th MSCI Japan: ______
May 15th EWJ: $14.98
May 15th MSCI Japan: 1,037.268 (in Yen); 3,391.780 (in USD)

March 16th N225: 16,096.21
March 16th EWJ: $13.79
March 16th Yen/USD: 117.13
March 16th MSCI Japan: 1,010.180 (in Yen); 3,110.551 (in USD)

The difference in EWJ between the two dates is 8.6% and the difference in the exchange rate is nearly 6.0%. The difference in the N225 is about 0.4% and I expect EWJ to trade lower today in reaction to the N225 and overall Japanese market tanking. It should be fairly obvious that despite the N225 being at almost the same level as it was two months ago EWJ is up 8.6% comparatively as of yesterday's close because of the effects of the exchange rate. Note that the difference in the MSCI Japan Index in yen denominated values between the two dates is 2.68% whereas in dollar denominated values it's 9.04%.

Using the N225 merely as a guide, the yen denominated value of the MSCI Japan Index will likely approach a level similar to the 0.4% differential we found in the N225 above since the N225 fell by nearly 2.0% today. The dollar denominated value however may not fluctuate by as much since it appears the yen is trading stronger against the dollar compared to yesterday. Finally, we'll find that the dollar denominated MSCI Japan Index and thus EWJ maintain a premium over the N225 because of effects of FOREX.

The N225 is down 8% since its peak on April 7th at 17,563.37. EWJ is down 3.67% since its peak on May 9th at $15.55.

So my advice to those following and investing in Japanese stocks is to continue checking the movement of the N225 but also to closely watch the MSCI Japan Index values (see http://www.msci.com/) and the Yen/USD exchange rate.

3-month chart comparing EWJ, ITF, N225, and Yen/USD

Data sources: www.msci.com; www.x-rates.com; Yahoo! Finance U.S./Japan

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Steven Towns

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