Double Your Money Shorting Japan

By Travis Johnson, Stock Gumshoe, February 21, 2009

Here’s how this ad begins:

“Industrial output dropped 35% in December
“Exports sank 46% from 2007
“Unemployment to hit 6% in 2009
“Sony, Nissan and NEC are warning of huge losses that will eliminate tens of thousands of jobs
“Japan’s economic minister warns, “The worst is yet to come.”

Well that sounds nasty, eh?

Robert Hsu has finally thrown in the towel on at least one of his beloved Asian economies — his more expensive newsletter, Asia Edge, was designed to help people take advantage of the financial rise of Asia, with a broader mandate than his China Strategy letter that focuses just on the Middle Kingdom.

And now, he’s telling everyone to get out of Asia’s most mature stock market, and to bet against it:

“… if you have any money in Japanese stocks, please get it out NOW and then add my Japan-shorting ETF to your holdings TODAY.

“As you’ll see in tonight’s Asia Edge (posted online now), the Japanese economy is not only on the verge of a mammoth free fall …

“…but your quick action today will determine your future wealth.”

This isn’t a particularly sneaky teaser — he doesn’t tell us the name of the investment he’s recommending to his Asia Edge subscribers, but he does say that he’s telling them to use a special ETF that lets you bet double against Japan’s stock market.

And there’s only one of those.

So what Hsu wants folks to do is buy shares of the UltraShort MSCI Japan ETF, (ticker EWV).

This is an ETF that, like all the ProShares UltraShort ETFs, tries to return twice the negative daily performance of the underlying index. The underlying index is the MSCI Japan Index, so if that index falls by 1% in any given day, the ETF is supposed to rise by 2%.

I won’t argue in favor of Japan — it certainly seems true to me that they depend heavily on exports, particularly to China and the U.S., that they have had a troubled and often barely growing economy for more than a decade even before this latest crisis, that they have terrible problems with inbreeding in their biggest corporations, and they have an aging population and a fear of immigrants that will make it almost impossible for them to grow in the future. Nothing about Japan’s stock market really appeals to me, though I’m sure there are some fine and profitable companies that I don’t know about. Throw in the fact that their currency has done well against the dollar, and their exporting companies even get a short term beating.

But of course, neither I nor Robert Hsu was the first to notice this — betting against Japan is not exactly contrarian here, this UltraShort ETF is up close to 50% so far this year (though it’s well off its highs of last Fall, when almost every UltraShort ETF was setting crazy records).

He thinks the downturn will accelerate over the next six months, and that it might take five years for Japan’s stock market to recover, which may well end up being true, I certainly have no idea.

So … do you want to get in on this trade and bet against Japan? That’s your call — I will just offer the standard warning about Short and UltraShort ETFs: They are not for the faint of heart, and they are not particularly designed for those who wish to make long term bets.

The key to these ETFs is that they use derivatives to try to double the return or the negative return of an index each day. And while they aren’t perfect in matching that performance, they at least often come close to hitting that target. But if you want to buy this ETF and hold it for six months because you think the Japan Index will fall between now and next Fall, you may well end up with a surprise.

To explain what I mean, look at a chart comparing the standard MSCI Japan Index ETF (EWJ) with this double short ETF (EWV).

You can see that over the last six months the moves on the chart look like they mirror each other as you would expect … but look at the numbers. The Japan Index has fallen by about 25%. But if you had bought the DoubleShort EWV six months ago, you would be … even. The assumption of most investors is that you would have gotten a 50% return based on the negative 25% return of the underlying index over that time period, but it didn’t happen.

This disconnect for long term performance of particularly the UltraShort ETFs is not new, it is a byproduct of the leverage that these ETFs use and it has been discussed for many months, and it doesn’t necessarily mean that these kinds of investments aren’t worth a tumble if you want to make short term bets — just be careful if you’re counting on them as a way to ride a longer term trend. One never knows what will happen in the future, but you would have been better off, over the last six months, buying puts against EWJ than buying EWV.

Have you tried out Robert Hsu’s services? Click here to review th