Be Wary of ETFs Lifted by Japan's GDP Revision

NEW YORK (TheStreet) -- Japan witnessed its fourth consecutive quarter of economic growth enabling it to take back from China its position as the world's second-largest economy after beating gross domestic product expectations.

This growth could impact the iShares MSCI Japan Index (EWJ), the iShares MSCI Japan Small Cap Index Fund (SCJ) and the Vanguard Pacific Stock ETF (VPL).

The Japanese economy expanded by 4.5% in the third quarter of the year, exceeding analysts' expectations by 0.6% and eating away at the nation's massive deflationary gap. Furthermore, this expansion has led to Japan's minister of economic and fiscal policy to peg an estimated annual growth for the year at around 2.6%.

Although Japan has been exceeding growth expectations, it is important to take this outperformance with a grain of salt. The nation's economic growth was primarily driven by increases in private-sector inventories which further suggest that now that inventories have been replenished, production cuts are likely to prevail. Another driver behind increased GDP was an increase in domestic consumption driven by deadlines for subsidies for environmentally friendly vehicles and other economy boosting measures, which are expected to expire and have a negative effect on future consumption. In fact, these trends are already starting to prevail as unemployment rates have started to worsen, industrial output has started to decline, retail spending has started to taper off and exports are slowing down.

To put further strains on Japan's economic outlook, corporations are starting to practice more cautious with regards to investing, and policymakers are hinting at increasing the consumption tax rate to procure money for the nation's aging population.

At the end of the day, when it comes to economic growth, Japan faces an uphill battle and is likely to lose its place as the world's second largest economy sooner rather than later.

• iShares MSCI Japan Index allocates nearly 19% of its assets to the consumer discretionary sector;
• iShares MSCI Japan Small Cap Index Fund allocates nearly 20.75% of its assets to consumer discretionary and is more correlated to consumer sentiment in Japan than ETFs which track and hold large-cap stocks;
• Vanguard Pacific Stock ETF allocates more than 60% of its assets to Japan
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Written by Kevin Grewal of SmartStops in Houston

Grewal has no positions in the stocks mentioned.

Kevin Grewal is the founder, editor and publisher of ETF Tutor and serves as the editor at www.SmartStops.net , where he focuses on mitigating risk and implementing exit strategies to preserve equity. Additionally, he is the editor at The ETF Institute, which is the only independent organization providing financial professionals with certification, education, and training pertaining to exchange-traded funds (ETFs). Prior to this, Grewal was a quantitative analyst at a small hedge fund where he constructed portfolios dealing with stock lending, exchange-traded funds, arbitrage mechanisms and alternative investments. He is an expert at dealing with ETFs and holds a bachelor's degree from the University of California along with a MBA from the California State University, Fullerton.