February 15, 2025
Are you hedging against a potential decline in the United States of Musk?
You should. While we hope that the Trump economy works and that the U.S. dollar and U.S. stocks continue leading the financial world, there is always a chance of things turning out for the worse. IN that case, you want to find yourself in a position where you don't stand to lose it all. Remember that the first rule in investing is diversification. Never put all your eggs in one basket.
Buying the Japanese Yen and investing in Japanese stocks makes sense these days. The Yen is still trading at near record lows. Although the Nikkei 225 is close to record highs, valuations seem very reasonable and affordable when compared to the S&P 500.
What is hedging in investing?
Hedging in investing is a strategy used to reduce or manage risk by taking offsetting positions in related assets. Hedging acts as "insurance" against potential losses in a portfolio. Hedging typically involves investing in assets that move in the opposite direction of your primary investment, or that at least do not move in the same direction at the same speed or magnitude. This helps protect against downturns due to instability or volatility.
Common Hedging Strategies
- Diversification. Holding different asset classes (stocks, bonds, commodities, and real estate) to reduce exposure to a single market event.
- Safe-Havens. Buying gold, U.S. Treasury bonds, or the Japanese yen as protection during market downturns.
- Forex. Buying foreign currency ETFs (e.g. FXY) to mitigate currency devaluation risks.
- Short Selling. Selling borrowed stocks to profit if their price drops, which can offset losses in a declining market.
- Derivatives (Options & Futures). Investors may buy options to protect against stock price declines. Future contracts can be used to lock in commodity prices (e.g., oil or gold).
Hedging doesn’t eliminate risk but can help reduce potential losses. Hedging comes at cost (e.g., premiums for options, lost upside potential).
The Japanese Hedge
Among the many different ways to hedge your portfolio, the "Japanese Hedge" is one to consider. In our view, this entails having about 5% of your portfolio between exchange traded funds (ETFs) that track the Japanese Yen (e.g. FXY) and the Nikkei 225 index (e.g. NKY).
The Yen
Over the years, many financial analysts and strategists have suggested that investors should consider the Japanese yen as a hedge against potential declines in the U.S. dollar and corrections in the U.S. stock market. The yen is traditionally viewed as a safe-haven currency. During past periods of global market volatility or economic uncertainty, investors have sought refuge in the yen, leading to its appreciation. Analysts like Dhaval Joshi of BCA Research have highlighted the yen's potential as a protective asset, noting that the yen could serve as a hedge against U.S. tech stock weakness. Geopolitical events, such as U.S. tariff policies and tech sector fluctuations, have prompted investors to seek assets less sensitive to U.S. policy changes. The yen and Japanese stocks tend to emerge as preferred choices in the context of tariffs and geopolitical volatility that may affect U.S., Canadian, European, and Chinese stocks.
The Nikkei 225
Over the past five years, the Nikkei 225 index (top 225 Japanese stocks) has demonstrated notable growth, reaching significant milestones. In December 2024, the index closed at 39,894.54 points, surpassing its previous all-time high from 1989. Year to date, the Nikkei 225 index has lost about 2%, standing as of February 14, 2025, at 39,149.43. Looking ahead, various forecasts suggest continued upward momentum for the Nikkei 225. A Reuters poll from August 2024 projected the index to reach 42,500 points by the end of 2025, citing attractive valuations, low interest rates, and ongoing corporate reforms as contributing factors. Some analytical forecasts anticipate the Nikkei 225 reaching 51,635.43 by the end of 2029.
However, it's important to note that market analysts also anticipate potential volatility in Japanese stocks. For instance, InvestingHaven predicts increased fluctuations in the Nikkei 225, especially in the latter half of 2025. Also, note again that it took 35 years, from 1989 through 2024, for the Nikkei to 225 to surpass its historic rise during the 1980s bubble in Japan. In any event, current valuation of Nikkei index (225 leading Japanese stocks) seems very favorable when compared to the S&P 500 (leading 500 U.S. companies).
As of mid-February 2025, the S&P 500 index has a total market capitalization of approximately $51.45 trillion USD, which gives us an average market capitalization of about $103 billion USD per company. In contrast, the Nikkei 225 index has a total market capitalization of approximately ¥710.44 trillion JPY ($4.666 trillion USD), which equates to an average market capitalization of about ¥3.16 trillion JPY ($20.75 billion) per company. That is, the average Japanese leading stock is valued at 20% the valuation of a leading U.S. stock. If U.S. stocks were to experience a correction in the coming years, it would not be inconceivable to see the Japanese stocks either maintaining their valuation or increasing it a little.
In summary, the Japanese yen and the Nikkei 225 are two asset classes to consider when hedging against potential U.S. dollar depreciation and U.S. stock market corrections. Investors are advised to stay informed about monetary policies and global economic developments when considering such positions. To invest in the yen, consider the "FXY" ETF. To invest in the Nikkei 225, consider the "NKY" ETF. Having 5% of your portfolio between those two ETFs may play well as a hedge against a potential economic downturn in our new country, the United States of Musk.
Now you know it.
www.creatix.one
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