After hitting an all-time high in 1989, Japan’s Nikkei stock index plummeted 80% over the 13 or so years that followed. Dubbed “The Lost Decade,” Japan witnessed not only a precipitous decline in stocks prices, but in property values, employment and interest rates as the nation entered a systemic depression.
While Japan benefited from surging growth across Asia in the mid-2000s, structural problems persisted. And, like the rest of the world, Japan was smacked with the collapse of the global financial system in 2008 and the shadow of China’s slowing growth.
Then, in late 2012, investors cheered as a new government seemed to have cracked the code on reviving the economy.
The Liberal Democratic Party (LDP) swept the Japanese elections, bringing Shinzo Abe back as prime minister on his promise to increase public spending and push for more accommodative monetary policy in what was collectively known as “Abenomics.”
The new government relied primarily on monetary stimulus at first, announcing quantitative easing programs in April 2013 and October 2014. But something more was needed to cure persistent deflationary pressure and slow growth after a surprise announcement in November 2014 showed that the economy had slipped into a recession, contracting for two consecutive quarters.
This sparked calls for fiscal stimulus spending, and in late December of that year, Abe approved a $29 billion package that included infrastructure rebuilding, fuel subsidies and vouchers for consumer spending.
We can see investors’ reaction to these key events on the chart of iShares MSCI Japan (NYSE:EWJ):
EWJ rebounded as Japan dissolved the lower house of its parliament to allow for an early general election, which the LDP was widely predicted to win. And in just over six months’ time, shares soared more than 40% as Abe took office and the Bank of Japan rolled out a historic $1.4 trillion monetary stimulus program.
Additional quantitative easing in October 2014 did not seem to be met with quite the same enthusiasm. But after Abe unveiled his $29 billion fiscal stimulus bazooka in late December, EWJ began a sustained advance that resulted in a more than 20% rise from its lows within four months.
Since the mid-2015 highs, though, investor sentiment has fallen on weak economic growth and concerns that monetary policy has not been as effective as hoped.
Japan’s GDP contracted by an annualized 1.4% in the fourth quarter, and February retail sales dropped 2.3% from the previous month. This has again ignited calls for fiscal stimulus. In fact, a recent survey by TV Tokyo showed 55% of respondents supported more government spending to jumpstart the economy.
Prime Minister Abe cooled rumors of another stimulus package, but he agreed to front-load the government’s record 2016 spending budget, which took effect this month. He said the $850 billion budget will be implemented “as quickly as possible” for public works and defense spending.
Even if the Japanese government holds off on another fiscal stimulus program, front-loading the new budget should help move the needle on the economy and improve sentiment for Japan’s stock market.
Amplify an 8% Move in EWJ Into a 122% Return
EWJ currently trades for just 13 times trailing earnings. That’s a 45% discount to the S&P 500 and leaves plenty of room for upside on even the slightest improvement in sentiment.
I’m setting my price target for EWJ at $12, which is 8% above the market price but would still only be about 14 times trailing earnings.
Using a simple call option strategy, we can leverage that upside into 122% profits.
With shares of EWJ trading at $11.07, we can buy an EWJ Jun 11 Call for about $0.45 per share ($45 per contract, which control 100 shares). The breakeven price is $11.45 ($11 strike price plus $0.45 option premium), which is 3% above the market price.
If shares hit my $12 target before the option expires on June 17, the call will be worth at least $1 ($12 stock price minus $11 strike price) for a 122% return in 72 days. Set a good ’til cancelled (GTC) sell order at $1 for the option after opening the position.
As you can see, call options offer an extraordinary amount of leverage and limit the dollar amount you have at risk. If you want more information on how to get started using basic options in your portfolio, follow this link.
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