Why Japanese and Chinese Stocks Are Diverging and How to Play Them Here

In regional equity allocation, Japan and China often act as a financial seesaw. When one market attracts international inflows, the other frequently suffers outflows. 

I started in the investment business way back in 1986, and at that time, Japan had just entered the top tier of the equity world. It was added to the MSCI EAFE Index, a global stock market benchmark, that year. 

Japanese companies were put on a pedestal for a brief period… until the 1987 crash changed everything. Since that time, Japan has been on a long climb back.

All the while, China’s stock market, while still considered “emerging” by some, is one of the largest in the world. 

So what should an investor looking to diversify out of pricey U.S. mega-cap stocks do? Let’s investigate.

Recently, the iShares MSCI Japan ETF (EWJ) and major China vehicles like the iShares China Large-Cap ETF (FXI) have broken away from each other, moving in opposite directions. We can see that’s actually reversing from the pattern of the past 12 months, in which FXI lagged by more than 20%, and now trades at a steep price-earnings discount to EWJ.

Here’s EWJ’s recent topping pattern. It is early, but the 20-day moving average just started to roll over, and the percentage price oscillator (PPO) indicator at the bottom of the chart is crossing into negative momentum territory. 

By contrast, here is FXI. Again, this is not what I’d call a firm breakout. But in this weak global stock market, it looks much better than most. So these major markets, Japan and China, are moving in separate directions.

Understanding why this divergence occurs — and what history says about its duration — requires examining policy divergence, currency mechanics, and institutional capital rotation.

Central Bank Policy: It’s Just Different 

The Bank of Japan (BOJ) has been moving away from decades of ultra-loose monetary policy, raising interest rates and unwinding yield curve control. Higher domestic rates bolster the Japanese yen, but they also compress valuation multiples for export-heavy Japanese equities and create friction for global yen carry trades.

Conversely, the People’s Bank of China (PBOC) and Beijing have enacted aggressive monetary easing and targeted fiscal stimulus to support domestic growth and equity markets. Cheap liquidity in China is driving a tactical rebound in beaten-down Chinese equities.

Valuation Arbitrage and Capital Rotation

Between 2022 and 2025, international allocators used Japanese equities as their primary Asia allocation, driving the Nikkei and EWJ to multi-decade highs on corporate governance reforms. Meanwhile, Chinese stocks were sold off to historical valuation lows. Once Japanese equities reached full valuations alongside BOJ rate hikes, global funds began taking profits in Japan and reallocating capital into deeply discounted Chinese tech and large-cap shares.

Has This Happened Before? 

Yes, most recently in late 2022 into early 2023. Following China’s economic reopening announcement, Chinese ETFs experienced a whopping 50%-plus rally in about three months, during which Japanese equities traded sideways as global capital temporarily abandoned Tokyo to chase the Beijing rebound.

When central bank policies or growth expectations diverged significantly between Tokyo and Beijing, cross-border equity flows flipped almost overnight. So, what usually happens next?

Historically, extreme performance spreads between Japan and China ETFs do not persist indefinitely. They typically resolve in two stages:

Initial policy-driven rallies in China often run into headwinds. It might be real estate debt, consumer sentiment, or ongoing trade friction. Once the initial surge in FXI exhausts its valuation discount, buying pressure slows down.

And, as Japanese corporate governance reforms (such as share buybacks and dividend increases) continue to improve fundamentals, institutional money eventually flows back into EWJ once currency volatility settles.

My bottom line is this: I’ll trade FXI and perhaps use the ProShares UltraShort FTSE Japan -2X ETF (EWV), which double-shorts Japanese stocks, on a short-term basis. But there’s nothing in either FXI or EWJ that convinces me they are not going to be caught in the web of selling that seems to pick up each week. 

Rob Isbitts is a semi-retired CIO, former fiduciary investment advisor, and Barchart columnist. Check out his other work at ETFYourself.com (featuring the Fresh Charts weekly trading post), and ROAR.PiTrade.com, helping investors to better-manage their own portfolios.