That's why investors should give the world's second-largest economy serious consideration over the longer-term. Real estate prices, particularly in central Tokyo, are up for the first time in more than a decade. Wholesale prices have been rising for the past 18 months, signaling the beginning of an end to a long, difficult deflationary period. Japanese banks, which have been troubled for years, have cleaned up the problem loans on their balance sheets. Corporate profits are at record levels, with bellwethers such as Mitsubishi Electric Corp. () raising their estimates for the coming fiscal year.
Japanese companies are starting to become more shareholder-friendly. Corporate governance is improving. In addition, many companies are paying meatier dividends for the first time or increasing payouts that had been paltry in the past. The dividend yield on Japanese stocks is about 1.5%, not that far behind that of companies in the Standard & Poor's () 500-stock index.
The Japanese consumer is in better shape, with consumer confidence on the rise. "Incomes have been steady, bonuses are increasing," says George Greig, manager of the William Blair International Growth Fund. A stronger yen -- it's up almost 10% against the U.S. dollar in 2005 -- gives Japanese households more buying power.
To capitalize on these improving economic trends, Brent Lynn, manager of the Janus Overseas Fund (), owns shares of banking giant Mizuho Financial Group and office-space agent Mitsubishi Estate. Meanwhile, William Blair's Greig likes retailers, including Yamada Denki, an electronics chain, as well as Komeri, a home-products retailer. With companies finally replacing obsolete equipment and upgrading facilities after a 20-year lull, Lynette Schroeder, manager of the Driehaus International Discovery () fund, is betting on machine tool manufacturer Okuma and construction-machinery giant Komatsu.
Although it's hard to find many bears right now, there are risks. Japan still depends on a strong U.S. economy to provide a big market for its high-end goods such as DVD recorders and luxury cars. A downturn in China could also leave Japan's exporting sector exposed. While many reforms are under way, "you don't see a lot of fast change," says Andrew Johnsen, a fund manager at Boston Co. Asset Management ().RETAIL DETAIL
The risks aside, lots of new money is heading East. U.S. investors have been putting record sums into funds that invest in Japan -- $1.3 billion since mid-August, according to AMG Data Services. Funds are an easier way to invest in Japan than trying to build a portfolio stock by stock. Stick to a fund with a seasoned manager, below-average expenses, and good performance. At Matthews Japan Fund (), for instance, veteran manager Mark Headley is betting on increased consumer spending. Also he's been stocking up on financial companies. "There are very significant growth opportunities to bring better services to the long-ignored average Japanese citizen," Headley says.
Another option for investors is a low-cost exchange-traded fund which tracks major Japanese equity indexes, such as iShares MSCI Japan Index () or Vanguard Pacific Stock VIPERs (). (The Pacific stock fund is about 73% invested in Japanese stocks.)
Well-known Asia investor Marc Faber is one of the biggest bulls. He predicts the Nikkei could rise by as much as 40% in three years. Given the run-up in the past few weeks, there's no need to rush in. "We believe the market is overheated in the short term," says Citigroup () strategist Tsutomu Fujita, who is more bullish for the long term. Since investors have been waiting for what seems like an eternity for Japan to bounce back, a few more weeks shouldn't make much difference. By Lauren Young