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Last Call for Japan?

Don’t look now, but Japanese stocks – yes, Japanese stocks – keep climbing higher.

I alerted you to the budding rally two weeks ago, and it’s only gaining momentum.

Over the last month, the Nikkei 225 Index is up 10%, nearly quadrupling the return of the S&P 500 over the same period.

This rally’s certainly been a long time coming, and it’s still got plenty of room to run.

Here’s why and – most important – an update on my favorite ways to profit from it.

Cheap and Still Ignored

It’s hard to argue against buying assets on the super cheap. And that’s exactly what Japan offers… even after the latest uptick.

You’ll recall that back in June, when I last made you aware of the tremendous bargains in Japan, the average Japanese stock was selling for $0.87 on the dollar, based on price-to-book ratios. And the average Japanese small-cap stock was trading for just $0.59 on the dollar.

Well, even after the latest rise, both large-cap and small-cap Japanese stocks remain undervalued. Take a look:

As I’ve mentioned before, U.S. stocks aren’t terribly expensive right now. Even after three-plus years of rallying. So the fact that Japanese stocks are selling at discounts of anywhere from 37.8% to 82.2% compared to their U.S. counterparts (depending on the valuation metric), makes the opportunity all the more compelling.

Of course, there’s a catch. (There always is, isn’t there?)

The biggest threat to an investment in Japanese stocks remains the yen. If it weakens, which is widely expected, it promises to cut into any potential profits earned via capital appreciation, since most Japanese funds trading on U.S. exchanges are denominated in dollars.

You see, when you buy the fund, the manager exchanges your dollars into yen to purchase stocks in Japan. And when you decide to sell the fund, the manager sells those stocks and exchanges the proceeds from yen back into dollars. So if the value of the yen falls during that period, the fund gets back fewer U.S. dollars – and, in turn, so do you.

Long story short, if we’re going to buy Japanese stocks, we need to hedge our currency exposure. And here are three easy ways to do it…

~ WisdomTree Japan Hedged Equity Fund (DXJ): As the name suggests, this ETF hedges its exposure to the yen, while investing in some of the largest dividend-paying Japanese stocks. So it provides two investments in one for investors, making it preferable to the most popular large-cap Japanese ETF, the iShares MSCI Japan Index Fund (EWJ). A reasonable expense ratio of 0.48% and a 2.4% yield round out the case for the WisdomTree ETF.

~ WisdomTree Japan SmallCap Dividend Fund (DFJ): As you can see in the table above, Japanese small caps represent the best bargains. Even better than being the cheapest, they also historically outperform large-cap stocks. And the beauty about small caps is that they come with a built-in currency hedge.

Since small-cap companies primarily serve the domestic market, they don’t rely heavily on exports. So a strong yen doesn’t significantly hamper their profitability, which is precisely what makes this fund – which provides exposure to more than 350 small-cap dividend payers – so attractive (and safe). It pays a modest dividend, too, of 2%.

So, again, we’ll get paid to wait.

~ Super Cheap, Small-Cap Japanese Closed-End Fund: There’s no reason we should settle for simply buying Japanese small-caps on the cheap – when we can buy them even cheaper. And we can do just that with the closed-end fund I recommended to WSD Insider subscribers.

As you know, closed-end funds can trade at a premium or discount to Net Asset Value (NAV). And right now, this fund is trading at a compelling 13.5% discount to NAV. In other words, it’s trading below its liquidation value at about $0.86 on the dollar.

Now, it’s not uncommon for this fund to trade at a discount. But a discount as high as 13.5% is pretty rare.

So this bargain won’t last forever. The same goes for all Japanese stocks.

Bottom line: The time to buy Japan is now. Momentum is building, yet Japanese stocks remain grossly undervalued. But they won’t stay cheap forever. So don’t miss out.

Ahead of the tape,

Louis Basenese