There's a Rising Sun for Japanese Stocks

So far he's been right, and other investors are starting to heed the call.

"We expect foreign investors to be the central player in Japan's stock market," says a Morgan Stanley research report released last week. "We believe they will buy Japanese stocks; stocks are more attractive than bonds during a global economic recovery, and Japanese companies are likely to post higher earnings growth, aided by reform, than their U.S. counterparts, which are already in good shape."

The numbers lend support to the Japan bulls.

For the year to date, the total return for the Nikkei 225 index is 9.43%; for the past 12 months, it is 46.28%. The S&P Topix Core 30, which includes large-cap, well-known stocks with U.S. listings, such as Toyota (TM Quote), Hitachi (HIT Quote) and Canon (CAJ Quote), is up 7.3% for the year to date and 39.2% for the 12 months since March 2003. The Topix Large 70, which includes many companies that benefit from increased domestic consumption, such as Mizuho Financial Group and Softbank, rose 13% for the first three months of this year and 49.9% in the past 12 months.

Analysts say this shows domestic demand is growing. That key component of recovery was absent from the market recoveries of the past decade, which didn't last.

"Since the early '90s, they've touched bottom, they've gone back up and gone sideways, and that's happened anywhere from eight to 10 times," says Lipper senior research analyst Andrew Clark. "They're at a turning point here. You have to remember that domestic demand is two-thirds of Japanese GDP, and that never appeared in the last economic recovery, short-lived as it was."

Returns from top-performing mutual funds give weight to the optimistic outlook.

The $3.2 billion Matthews Japan Fund (MJFOX) produced a total cumulative return of 103% over the past 12 months, and the $1 billion Fidelity Japan Smaller Companies Fund (FJSCX) returned 97% over the same period, according to Lipper.