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Toyota Weighs on Japan ETF

The latest problems with the automaker is one of the many factors that dictate the direction of the ETF.
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) -- Some optimistic information from Japan may give

iShares MSCI Japan Index

(EWJ) - Get iShares MSCI Japan ETF Report

a short-term boost, but the investment picture looks gloomy in the mid- to long-term.

Prominent in the news are the problems that lie ahead for


(TM) - Get Toyota Motor Corp. Report

as speculation circulates today about recalls for its hybrid Prius model in Japan, the U.S. and Europe. As of 10:00 a.m. EST, TM shares were down by 2.3% whereas the broader market indices were only marginally negative.

However, Toyota accounts for 5.2% of EWJ, so the fund's movements will not be prominently decided by the company's performance. For example, even a 10% decline in Toyota would only bring EWJ down by 0.5%.

Investors, though, must keep in mind that Toyota has lost almost 20% in roughly the past two weeks along, and as Toyota's recall saga drags on, the company will be a deadweight anchor on EWJ if it continues to head for the basement.

Toyota, EWJ's largest holding, exemplifies how the country fund does not give any company a particularly weighty allocation. This is not always true of country-specific ETFs, meaning, in the case of Japan, factors affecting the whole country or entire industry sectors will be more useful in determining EWJ's direction.

For instance, Sumitomo Mitsui bank beat analyst expectations today when it reported earnings for the previous quarter. It only accounts for 1.9% of EWJ, but the company is Japan's second largest bank and its performance in the last quarter, which saw costs related to bad loans drop by almost 50%, could be taken as a bellwether for Japanese financials, a sector that accounts for 17.2% of EWJ.

However, before declaring a parade for Japanese banks, it should be noted that loans decreased in January from a year earlier by the most in four years, meaning corporations are still hesitant to expand their capital investments as the economy recovers.

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This is something that could turn around though in the coming months as corporate bankruptcies fell compared to a year earlier for the month of January. This is the sixth month in a row that monthly bankruptcies have fallen. However, a report today showed that the current account surplus in Japan increased for the fifth month in a row in December due to strong demand for exports from Asia and China especially.

Since Japan's economy relies heavily on exports, I suspect that the decreasing bankruptcy figure is working in correlation with the increasing current account number.

The question then is whether the markets in Asia can support the Japanese export picture going forward as the euro has weakened to incredible lows compared to the yen recently. Europe is a large market for many Japanese companies, such as Nikon, which draws 25% of sales from the continent, according to



This is worrisome because the export numbers for the first three months of January now rely heavily on an asset bubble not bursting in China and on government stimulus continuing to support business and consumerism there. Since China's asset bubble was debatably caused by the government's stimulus, something has got to give, meaning I do not like the prospects for Japan continuing to keep exports alive based on Asia demand while the euro weakens and the dollar remains weak.

Further darkening the mid- to long-term prospects of EWJ is something Jim Cramer pointed out this morning in his blog about how the media loves the debt contagion theory and is looking for its next victim after the European PIGS.

Japan has enormous debt and S&P issued a forewarning outlook last month for their rating on Japan's government debt. If the media grabs a hold of the country's debt problems when it gets bored in Europe, it will devastate EWJ the way it did for euro-zone country ETFs last week.

EWJ though is one of the top 10 most popularly traded ETFs for the past three months, indicating to me that there is a lot of short-term interest in the fund. For these traders, EWJ may be cheered from a report next week that is expected show that overall economic growth for the country expanded in the last three months of 2009, especially if TM can refrain itself from diving downwards.

Also, if the growth report strengthens the yen against the dollar, this will help EWJ in the short term since the securities of the fund are priced in yen and then converted to dollars. However, the mid-term and long-term outlooks for EWJ depend on whether the euro recovers from its slide and whether or not the government debt situation in Japan becomes the next financial media darling.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion does not have any holdings in the equities mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.