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By definition, a downgrade of a nation's credit rating signals worsening economic conditions. It's the financial markets' equivalent of a scarlet letter screaming "investors beware." And it often drives money out of a country.

On Thursday,

Moody's Investors Service

, the powerful U.S. ratings agency, announced that Japan's sovereign debt -- debt issued by the government -- was under review. In November 1998, Moody's stripped Japan, the world's largest creditor, of its pristine AAA status.

The announcement comes on the heels of a run of bad economic news from the world's second-largest economy, most notably hints from officials that Japan has slipped back into recession. There were more negative developments earlier this week, when Tokyo Governor

Shintaro Ishihara

suggested his city would tax the profits of large banks in Tokyo, an idea that undoubtedly irked the mandarins at the

Ministry of Finance


Despite the confluence of seemingly foreboding events, investors may want to consider Japan an exception to the rule that the threat of a downgrade will diminish their portfolios.

Japan actually looks pretty good as an investment destination for U.S. retail investors -- and has been for some time -- particularly with respect to Japan-only mutual funds. Those funds have been the second-best performers as an asset class for the last 12 months, bested only by technology funds, according to


. For example, the


Warburg Pincus Japan Small Company Fund is up 276% over the last 12 months and the


Fidelity Japan Small Companies saw gains of 196% over the same period.

It's all part of the disconnect in contemporary Japan, where the performance of the stock market and the performance of the government appear inversely correlated. During the same period that saw huge gains in mutual funds and their underlying stocks (the benchmark

Nikkei average

is up 40%), the Japanese government has been a poster child for ineffective management of the economy.

The government has spent money left and right to stimulate the economy. The stimulus worked for the first half of 1998, when there were signs of growth, but it has now sputtered. Meanwhile, important structural reforms, most notably in the banking sector, have stalled. The consequences of the government's actions -- and its inaction -- include a huge increase in debt, which is expected to equal a whopping 130% of GDP in 2001, by far the highest among industrialized nations. It was the increase in public debt that led Moody's to announce a review of the credit rating.

The conventional wisdom holds that the rise in the Nikkei is based on the belief that Japan has pulled out of its decade of economic troubles and is finally firmly on a growth path. Thus, some would argue that if the country is back in recession, it would make sense to avoid it at this time.

Instead of pulling out, however, investors should be bullish on the Japanese market, even if it makes sense to be bearish on the government's competence.

First, there has been a boom of corporate restructuring in Japan, which is becoming less Japan Inc and more This has led, says Suzette Valuz, assistant portfolio manager of the


Newport Pacific Japan Opportunities Fund, to "a new vitality in Japan. The restructuring announcements are just tremendous." While the government stagnates, business is becoming leaner and meaner -- and more profit-driven.

Second, the tech boom is just taking off in Japan, as Internet and cell phone usage climbs. The returns on Valuz's fund were 130% the last 12 months. As is the case with many Japan funds, it leans heavily toward tech and electronics. Even some of the nontech companies in the fund relate to tech somehow. She has included a regional bank named


, which is strongly promoting Internet banking and recently signed a deal with


, the huge net holding company.

Finally, it is almost certain that huge amounts of money will continue to flow into the Japanese stock market even if foreign investors stay away. Around 10 years ago, Japanese retail investors started placing their savings in postal savings accounts -- they are kind of like a certificate of deposit. According to Valuz, around $1 trillion will mature in the next 18 months, with trillions more in the years to follow. She conservatively estimates that 30% to 50% of that will move into mutual funds. With the fall in interest rates in Japan, the postal accounts now offer very little. Because Japanese retail investors are famously conservative, at least some will head toward the less risky mutual funds, she believes.

One might think a possible downgrading of the credit rating of Japan, the world's second-largest economy, the largest by far in Asia and the world's largest creditor, would be a problem for investors. It isn't.

David Kurapka's Global Portfolio (formerly Trade Winds) column appears Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at