Curbing a yen for Japanese stocks

Despite more interest in Japanese equities, experts are mixed over whether they're a smart investment.

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NEW YORK (Fortune) -- Investors have been putting more money into Japanese equity funds than they've been taking out for four straight weeks, according to fund flow tracker EPFR. The streak is the longest since the third quarter of 2008.

According to EPFR, investors are taking a more positive view of the export-dependent Japanese economy because they believe it will benefit from "demand from China... and the U.S. and the yen's recent depreciation versus the U.S. dollar."

So are investors onto something?

This question gets an adamant no from economist Carl Weinberg with High Frequency Economics.

"I think Japan has appeared to be a safe haven to some investors," he says, "and I don't understand it." He notes that industrial production there is down about 30% and exports have dropped almost 40%.

Moreover, Weinberg thinks Japan, with its huge fiscal deficit and exploding debt-to-GDP ratio, is in worse shape than Europe and North America. And he says he has found no evidence that the new government likely to take power after elections in August has any plan to close the deficit. "Structurally, cyclically, and super-cyclically Japan is flawed," says Weinberg. "I think Japan is economically broken."

Stuart Schweitzer, global markets strategist for J.P. Morgan's Private Bank, believes investors may be turning to Japan because they think the worst is over. When the credit crisis hit last year, "Japan suffered disproportionately," he says, "and people are hoping it will benefit disproportionately to the upside."

But Schweitzer doesn't completely agree with the optimists. "Every time Japan has started to do well, something has happened to knock it back down," he says.

Japanese manufacturing activity slowed severely last year and early this year, so it might rebound more than manufacturing activity in other places, he says. However, that may not translate into increased profitability. Japan's unit labor costs are reaccelerating, while in the U.S. they've been slowing. So U.S. manufacturers may get more of a boost from an economic recovery.

Investors might also be looking to get into Japan, because it's powered in large part by technology companies, Schweitzer says, and tech has been leading this rally. However, he notes that the economies of Singapore, Taiwan, Korea, and China are all more tech-heavy than Japan's.

Schweitzer thinks that the rest of Asia has been a better place to invest and expects it to remain so in the months ahead. "It remains incredibly dynamic and has huge tailwinds from developments in China," he says, adding that non-Japan Asia also has more policy support for growth.

His bottom line: "Japan is a country very slow to change, in contrast with much of Asia and America," he says. "I think there are more attractive places for capital these days."

Richard Jerram, chief economist at Macquarie Securities in Tokyo, doesn't think that U.S. investors actually have that much of an appetite for Japan right now. He sees the current rally being driven by domestic individual investors, not foreigners. He notes that this dynamic is unusual because typically foreigners are the most aggressive in recognizing cyclical swings.

Jerram believes that any investor enthusiasm is driven by the rise in production and exports during the second quarter, when export growth compared to the first quarter was the strongest on record.

While people recognize that, he says, they don't seem to be brimming with enthusiasm to put money into Japan.

"Skepticism in the durability of the improvement is leading people to be more cautious than in the past," he says. "They're probably too cautious. You should see positive earnings surprises in the next year." To top of page

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