Investors looking for a contrarianplay can spin the globe 180 degrees. Morningstar's Japan equity mutual fund category has had six losing years over the past decade, including three years in which losses topped 30%. So while the 10 years through the first quarter of 2010 have not been lucrative for domestic stock funds (annualized average returns under 1%) or the broad category of international stock funds (2.2%), they've been disastrous for Japanese stock funds; the annualized 10-year return for the category is a loss of nearly 7% a year. A buy-and-hold investor who put $1 into the average Japanese stock fund would now have a shiny 50 cent piece to show for it.

Anyone who believes in economic and investment cycles need look no further than Japan. The benchmark Nikkei 225 Index of Japanese stocks soared from 2,000 in early 1970 to nearly 40,000 at the end of 1989. The stock market and real estate bubbles burst then, triggering two decades of economic stagnation and deflation. As of this writing, the Nikkei 225 is roughly 75% below its peak, at approximately 11,000. Has the down cycle finally ended, launching a new 20-year spurt of rising asset values?

Some people believe this could happen. BofA Merrill Lynch recently released a survey of fund managers in which a majority said Japanese companies had the most favorable outlook of all worldwide regions. The debt crisis in Greece has dampened the appeal of Europe, while Japanese equities were viewed as a "cleaner cyclical play," BofA Merrill Lynch reported.

That is, a global economic recovery is apparently under way. International trade is likely to expand, and many Japanese companies that depend on exports may prosper from the pickup. The latest update from Matthews Asia Funds expressed a similar view: "Although sovereign debt issues in Europe remained a lingering concern, Japan's markets have been buoyed by the continued improvement in the underlying economy."

Of course there were years of economic growth in the 1990s and 2000s, yet Japanese stocks went south. Is this really different? "Judging from mutual fund managers, opinions on Japan are mixed," says Bill Rocco, senior analyst at Morningstar. "Some say emerging- markets exports will boost the Japanese economy, others say it's difficult to find good opportunities there."

THE RISING SUN SETS

Some of the difficulty stems from the Japanese economy, which has been weak. Japan has unsuccessfully battled deflation for more than 10 years, says Eric Meermann, a financial planner with Palisades Hudson Financial Group in Scarsdale, N.Y. "After the stock market and real estate bubbles burst, Japanese companies maintained excess capacity, which drove down prices," he explains. Consumers were not motivated to spend because they knew prices would continue to drop. Lower consumer spending reduced corporate profits, which lowered wages and further lowered spending, so the deflationary cycle continued, he adds.

Another problem lies in demographics, Meermann says; there are now about six Japanese in the work force for every retiree. "In 15 years, by 2025, the ratio will be 2:1. At some point, this will become unsustainable."

Three factors lead to this demographic danger-a low birthrate, little immigration and a high average life expectancy, Meermann says. The Japanese government supports many retirees for many years, so government debt is increasing. "We have that problem here, but Japan has more government debt than ours, relative to GDP," Meermann says.

DIFFERENCE OF OPINION

As mentioned, economies around the world appear to be ascending. Observers disagree, though, about how high this rising tide will lift Japan's boat.

Japanese economic data has been much stronger than expected recently, reports Raymond James Chief Investment Strategist Jeff Saut. "Japan's new export orders recently hit a six-year high, for example."

Frank Germack, director of the investment department at Rehmann Financial, agrees that some things are improving. "Prices may be falling back into line, for real estate and stocks," he says. "If deflation becomes less of a problem, there might be a loosening of purse strings in Japan-we could see more spending and investing."

In late April, Bank of Japan Deputy Governor Kiyohiko Nishimura said in a speech that, "Some beams of light are starting to break through a thick cloud of deflation. The effects of the pickup in the economy since the spring of 2009 can be considered to spread over to prices from now on."

At about the same time, though, Brian Rose, head of wealth management research at UBS in Japan, expressed a different view in The Wall Street Journal. "Output... is still down 6% from its peak in the first quarter of 2008," he wrote. "In this environment, prices have been falling simply because demand is weak."