No market has suffered more during the Fed’s boom bust cycle than Japan.  The timing of their own credit crisis in the early 90′s couldn’t have come at a worse time – just before the great innovative boom of the internet age.  To make matters worse, they didn’t begin to grasp the complexity of their problems until the U.S. and the rest of the world was slipping into a great recession of their own (please see here for our opinion on the current outlook for the U.S. deflationary battle).  And then there is the great recession of 2008.   But after years of abysmal market returns Japan might be the contrarian of all contrarian bets.  Here’s why:

• Japan is hands down the most hated market in the globe.   The consensus in our 2010 investment guide was underweight Japan.  If there is no one left to dislike Japan then there is a strong likelihood that Japan’s market will melt higher as the sellers have already positioned themselves accordingly.

• The Japanese market is cheap on a relative basis.  It now sells at just 1.4 times book value compared to 2.2 times emerging markets and 3.2 times China.

• Contrary to popular opinion, the debt problems in Japan could continue to serve as a near-term positive catalyst.  Any potential problems funding their deficit is likely to result in further quantitative easing which would be highly beneficial to stocks in the short-term.

• Perhaps most importantly, the Yen now looks overvalued compared to the dollar and the Euro.  In Japan’s export driven economy this could continue to benefit the Japanese economy.  The risk likely remains to the upside as we believe the Fed will be forced to act in H2 and could result in a much more robust dollar than many currently presume.  Any downside in the Yen would be positive for stocks.

Cullen Roche

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