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The time has come for me to admit that buying EWJ (an exchange traded index fund of large Japanese stocks) three years ago was a mistake. Much of the rise in EWJ over the past six months was the function of the appreciating Yen, which hit a 15 year high against the $US about a month ago. It was not, however, due to underlying stocks rallying in Yen terms.

As I have previously written, I am looking for $US to appreciate over the next six months. Down the road, the corresponding weakness in the Yen will be good for the large Japanese exporters, which are well represented in EWJ. However, any strength in underlying stocks will likely be lost once translated to $US.

Furthermore, Japan's economic future is now far from certain - two decades of deflation, aging demographics, huge government debt and dwindling personal savings are not helping. And so I am concerned that once the world gets over troubles in Europe, and especially in the unlikely event that Bernanke and the Fed are reasonably successful in the meantime reflating the US consumer economy by stoking inflation, all attention will turn to the much bigger problem that is Japan.

This eventuality carries a sizable downside risk for Japanese equities and without a correspondingly large upside potential, I see no reason to stay in Japan. The choice to jump ship before the end of the year is motivated by my desire to minimally offset unusually large capital gains I have taken earlier in the year, when it looked certain that the capital gains tax reduction we enjoyed in recent years would be no more. Now that chances for an extension in preferential treatment of capital gains beyond 2010 are much brighter, reducing current year’s tax burden makes more sense.

I ridded my portfolio almost entirely of exposure to Japan by selling my entire EWJ position today at $10.39 /share. My total loss in EWJ including dividends, but ignoring commissions over the little more than three years that I was in it is 21.1%.

Japanese flag

The stocks shouldn't move too much because of anything that japan is actually doing - Their currency is artificially depressed and even though the cost of capital there is at about a rate of 1%, you still can't make much of a gain on that because the average return is only about 4% compared to 12% for the USA - If you're into stock trading then you probably have nothing to worry about because a crash in japan won't totally effect us as terribly as everyone seems to think.

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Are you currently bullish or bearish on the economy and the stock market?:

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