Twenty years ago, Japan was like what China is like today. American MBA students studied Japanese to get an edge in the job market; Tokyo, not London, was New York's greatest rival as a global financial center; and business bestsellers included books with titles like "The Enigma of Japanese Power" and "The Japan That Can Say 'No'." Blue chips on the Tokyo Stock Exchange were routinely trading at P/Es of more than 150 because Japanese companies were somehow "different." The list of the world's top banks was headed by Japanese names. And autoworkers in Detroit were taking sledgehammers to Japanese cars, even as the Japanese investors bought New York's iconic Rockefeller Center.

Then the bubble burst. After reaching close to 40,000, the Nikkei plummeted more than 70% from its record close set on December 29, 1989. Since then, Japan has all but disappeared from the radar screens of U.S. investors. Yet today, Japan is still the world's second-largest economy. Japanese companies like Toyota (TM) and Sony (SNE) have become as much a part of the fabric of American life as Coca-Cola and Microsoft. And while China and India grab the headlines, it's easy to forget that Japan's economy in real terms is about three times the size of China and almost about eight times the size of India. Conferences and panels on the emergence of China and India abound. Yet I cannot ever recall seeing an investment panel -- or a newsletter -- dedicated to Japan.

Japan's Recovery: A Nation of False Starts

It's easy to see why the world's love affair with Japan ended. The market spent the Roaring Nineties lagging the U.S. market, and another five years treading water. But as recently as 18 months ago, Japan looked like it was coming back. Since hitting bottom in March 2003, the Nikkei 225 index finally burst through the magic 17,000 in April of 2006, rising more than 120% in a three-year period.

That's right around the time when Japan's recovery was the subject of a session at the London Junto, a regular meeting of leading investors that I host. A quick survey at the end of the session confirmed that among a group of some of the most sophisticated investors in the world, there was not a single "Japan bear" to be found. At the time, I pointed out to my audience that the only thing "scary" about Japan was the level of consensus about it.

With the market locked in a trading range for two years since then and Japanese stocks in 2007 suffering through their worst year since 2002, the picture today looks very different. The Nikkei index fell 11.1% in 2007 to 15307.78 -- the market's first losing year in the last five. In fact, foreign investors have been net sellers during the past two quarters. That's the first time that has happened in 13 years. And this was during the same period that many Asian markets hit record highs.

Japan's Recovery: Back on the Radar Screen?

Perhaps surprisingly, strategists at major investment banks including UBS and Lehman brothers have picked Japan as one of their top global markets for 2008. A recent report by UBS argues that after spending almost two years close to the bottom of the global stock market performance tables, Japan is due for a bounce. Japan also tends to show a favorable performance for a year after the United States adopts a monetary-easing stance. UBS also expects personal consumption growth in Japan to remain strong this year and Japanese companies to improve their efficiency by using greater financial leverage to enhance their return on equity.

Lehman Brothers takes a different tack, but comes to a similar conclusion. Of the world's 23,000 mutual funds, a mere 16 have consistently generated positive annual returns during the past decade. (That's less than one out of 1,000!). And the one common factor these funds had was that they were overweight in Japan between January-March 2003 and October-December 2004. These same funds are overweighting Japan today. So, if these funds have it right, Japanese equities should have a strong 2008.

Japan also has become a relatively good value. Japanese blue-chip companies -- like car maker Honda Motor (HMC) and copy-and-camera maker Canon (CAJ) -- are trading near their lows for the year even while posting record profits. For the first time in recent financial memory, the 12-month forward P/E on the market is now down to 14 times. That's the lowest level in 24 years. It also means that Japan is trading lower than the global average of 16.7 times and 20 times for markets in the rest of Asia. On a price/book value basis, Japan is even cheaper, trading at about 1.5 times. That compares with a global average of about 2.4 times, 2.5 for the United States, and more than three times for other Asian countries.

Finally, Japan's currency, the yen, is the most undervalued major currency in the world. While a revaluation of the yen may impact Japanese exporters negatively, it also means that if you buy yen-denominated assets, those assets are going to get more valuable as the yen appreciates.

Jawboning by investment banks notwithstanding, it's still very tough to think of Japan's designation as a top market for 2008 as anything more than wishful thinking. A recent Bank of Japan survey showed business sentiment in the country had slipped to its lowest level in more than two years. Japan's domestic auto sales fell to a 35-year low last year to mark the fourth straight annual decline. The same Japanese management style that was widely admired 20 years ago for its long-term perspective is now derided for not focusing on creating immediate value for shareholders. And there is a sense that the pace at which Japanese companies have released innovative products onto the global market has diminished markedly during the past several decades. The bottom line? No matter how much you try, it's still very hard to get excited about Japan. Ironically, that may be the most bullish signal of all.