Mutual fund investors would be hard pressed to find a more contrarian bet than Japan. The Japanese economy is in serious trouble, in part because the soaring yen makes its goods so expensive in falling dollars.
But after a devastating first quarter, a number of portfolio managers and investors have started creeping back into Japanese equities. And so far, the wager has paid off.
The bellwether Nikkei 225 index, which fell more than 18 percent in the first three months of 1995, has risen 5.1 percent this month. To some, that looks like a classic example of what the trade calls a "dead-cat bounce" -- a reaction to the fall, not a sign of life. But other signs point to renewed interest in Japan as well.
Three weeks ago -- for the first time this year -- investors put in more money than they withdrew from the five largest Japan stock funds, according to AMG Data Services, a fund research company in Arcata, Calif.
Last week, a four-week moving average showed $2.7 million in new cash, double the amount a week earlier, for those funds.
Some managers also are encouraged by technical analysis, which uses charts of previous performance to predict future stock prices. Several times in the last three years, the Nikkei average has fallen close to 15,000, as it did in late March, and then rebounded sharply, gaining 20 percent to 30 percent over the next two quarters.
"The Japanese market offers the opportunity for a very profitable move over the next six to nine months," said Charles E. Cain, president of Cain Asset Management, a New York money manager who specializes in picking mutual funds for clients.
One mutual fund that's been buying in Japan is Merrill Lynch Pacific. "As the Japanese stock market has dropped, we've been adding to our position all year," said Steve Silverman, manager of the fund.
It now has 65 percent of its $1.5 billion in assets in Japan, up from 56 percent at the start of the year. The fund, up 0.9 percent this year, doesn't try to predict the market's overall direction. However, Mr. Silverman said, "We're finding a lot of individual companies that look like great values."
Japanese funds have moved higher this month in large part because of the falling dollar. The Japan Fund, which is the largest of the group specializing in Japan with $487 million in assets, has risen 3.9 percent, to $9.39 a share.
To the extent that mutual funds investing in Japan don't hedge their currency risk, American investors benefit from a stronger yen and a weaker dollar.
The opposite is also true, which explains the vast difference in performance among the nine Japanese funds tracked by Lipper Analytical Services, a funds research company.
For the year through Thursday, the tiny Wright Equifund-Japanese, whose $9.7 million in assets aren't hedged against currency effects, gained 0.7 percent. Warburg Pincus Japan did hedge its $24.5 million in assets -- and declined 21.3 percent through Thursday.
If the currency trend reverses, as it showed signs of doing last week, the top and bottom performers could switch places, because the funds that hedge would benefit. The stock market also stands to benefit from a weaker yen, since the Japanese economy is dependent on sales of its products abroad.
"What's caused the Japanese funds to rise so far this month -- the strength of the yen -- is negative for the stock market," Mr. Cain said. "If the yen stabilizes or comes down, in the long run that will be good for Japanese stocks. I'm inclined to believe that will happen."
The technical signs are promising for the Nikkei index, Mr. Cain said. The Nikkei average's weekly closing prices have ranged from about 15,000 to 21,000 for nearly three years. Each time the index has fallen sharply and hit the lower level it has rebounded, reaching the upper limit within several months.
The recent strength could be setting the stage for an upward move in the Nikkei average of 20 percent to 30 percent by the end of the year.
To take advantage of that possibility, Mr. Cain said, he is considering buying Japanese specialty funds. "A well-diversified position within a portfolio would measure about 15 to 25 percent" assets, he said.
Of course, the yen might continue to strengthen, the Japanese economy might slump further and the Nikkei average could fall below 14,500, the level it last visited in August 1992.
Some international specialists consider that more than a mere possibility. David Herro, portfolio manager of the $877 million Oakmark International fund, has no assets in Japan and doesn't plan to start investing there anytime soon.
"If anything, the fundamentals in Japan are getting worse instead of better," Mr. Herro said.
While interest rates might appear to be almost as low as they can go -- the Bank of Japan lowered its discount rate to 1 percent recently -- Mr. Herro said that because Japan is in a deflationary cycle, real interest rates are two to three percentage points higher.
Mr. Herro predicted that the Japanese economy must go through much more fundamental restructuring before it can strengthen significantly. "The stock market is off 50 percent from its highs, but that was an inflated high," he said. "It's still overvalued by 20 percent to 40 percent."
Clearly, Japan has serious economic problems that aren't likely to be solved in a few months. But with pessimism about Japan so widespread and the Nikkei average down so far this year, some money managers see immediate promise in a few sectors of the Japanese economy.
About 27 percent of Franklin Pacific Growth fund's $51 million in assets is invested in Japan. William Howard, the portfolio manager, owns companies that should hold up relatively well in a slow or declining economy and that he expects to do well in the next five years.