Accommodative measures could support the Japanese economy, but a strengthening yen currency will weigh on exporters. Consequently, investors may find better opportunities in investing in Japan’s domestic market through small-cap exchange traded funds.

The yen currency has hovered around the 100-per-dollar level for over a year, so many of the country’s biggest companies won’t experience a yen boost from their export trades, writes Aaron Back for the Wall Street Journal.

The link between Japanese equities and the yen exchange rate has broken down, with the correlation between the yen and the broad Topix stock index down from a 0.98 over the past two years to near zero over the past few months – a 1 reading indicates perfect correlation whereas 0 reflects no correlation.

Consequently, the renewed focus on company fundamentals has partly explained the weakness in large Japanese companies this year. For instance, the iShares MSCI Japan ETF (EWJ) is only up 1.2% year-to-date.

Moreover, Bank of Japan board member Koji Ishida warned that domestic structural factors could further delay a rebound in export companies’ performances, reports Leika Kihara for Reuters.

“Exports continue to move sideways and lack momentum” as demand in emerging Asian markets remained weak, Ishida said in a speech.

Additionally, even if an improving global economy supports export growth, Ishida cautioned that overseas shipments may not expand much since many companies have shifted factories overseas.

“It’s also uncertain how much the (yen’s) decline will lead to an expansion in export volume,” Ishida added.

In contrast, small-cap Japanese stocks have been outperforming as they benefit from an expanding local economy. Year-to-date, the WisdomTree Japan SmallCap Dividend Fund (DFJ) is up 7.4%, iShares MSCI Japan Small-Cap ETF (SCJ) rose 7.1% and SPDR Russell/Nomura Small Cap Japan ETF (JSC) increased 5.3%. Additionally, the WisdomTree Japan Hedged Small Cap Fund (DXJS) , which hedges against an appreciating yen currency, is 6.1% higher so far thi syear. [Big Upside for Small Cap Japan ETF]

For more information on Japan, visit our Japan category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.