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By Tony D’Altorio

Japan can honestly claim some of the most unloved stocks in the world. After getting burned one too many times, international money managers won’t touch it anymore. And individual investors don’t trust it either, in large part because of its failure to regain more than half of its 1989 peak.

Yet somehow, foreign ownership in Japanese stocks has edged higher recently.

That could be a case of fools putting their hand on a hot stove again. But it also could indicate that Japan’s days as a dud are numbered. For the first time since at least 1980, Japanese dividend yields are beginning to look better than those in the U.S. For income-focused investors, that may indicate a significant shift worth buying into.

A Japanese Dividend Yield Convergence

French bank Societe Generale estimates that dividend yields in Japan and the U.S. will converge at 2.1% this year. But it forecasts that in 2011, that will change in Japan’s favor. Japanese brokerage firm Nomura agrees, projecting the S&P 500’s 2010 dividend yield at 1.9%. But it expects the benchmark Topix index – with a fiscal year ending March 2011 – to come in at 2.2%.

Nomura also expects the Topix to outpace the S&P 500 next year. And if both brokerages are correct, that marks a huge turnaround.

On dividend yields alone, Wall Street normally looked more attractive. Historical data shows that since 1980, U.S. yields have consistently topped Japan’s. But problems in the financial industry have led to those dividend payouts falling sharply. In 2007, financials paid 30% of the dividends doled out through the S&P 500; now they only account for 8.9%.

Howard Silverblatt, senior index analyst at Standard & Poor’s, called last year “devastating” and “the worst in [dividend] history.” And despite recent improvement, they remain down 13.9% over the past 12 months.

On the other hand, the difference between stock dividend and government bond yields makes Japanese stocks look cheap. Dividend yields on stocks are about 100 basis points or 1% higher than those on 10-year government bonds.

In contrast, 10-year U.S. government bonds give about 3%, which easily beats out the S&P’s 2%.

The End of Japan’s 20-Year Bear Market?

Japanese companies’ earnings are outpacing expectations, making them absolute steals, and perhaps showing a little light at the end of over a twenty-year bear market. This metric shows that there may be a little light beginning to shine on Japan’s stock market, as recently pointed out by Investment U’s own Alexander Green.

John Vail, the chief global investment officer at Nikko Asset Management, has covered Japan for 20 years. He says the Topix’s P/E ratio index is “as low as I’ve ever seen it.” He and a few other brave money managers even think it looks better than the U.S. overall.

Meanwhile, Japan’s small investors seem to agree. Since May, they’ve been returning to the market after avoiding domestic stocks for nearly two decades. Vail adds, “Given that long-term interest rates are so much lower than in the U.S. and the currency [yen] has more resilience… this makes Japan look relatively attractive..”

Indeed, a strong yen makes investing in Japan even more so for American investors, since it adds to any profits from capital gains or dividends. And incidentally, it just traded at a 15-year high versus the dollar.

Four Quality Ways to Invest in Japan

There are dozens of quality Japanese companies trading in ADR form in the U.S. That includes electronics giant Sony ADR (NYSE: SNE) and industrial conglomerate Mitsui ADR (NASDAQ: MITSY).

However, investors who want broad exposure to the entire Japanese market can choose between two excellent ETFs that focus on dividend-paying stocks:

  • WisdomTree Japan Hedged Equity Fund (NYSE: DXJ)
  • WisdomTree Japan SmallCap Dividend Fund (NYSE: DFJ)

In addition, there are two closed-end funds that currently trade at a discount to their net asset value (i.e. they trade below what the stocks in their portfolio are actually worth):

  • Japan Equity Fund (NYSE: JEQ), which currently trades at over a 12% discount.
  • Japan Smaller Capitalization Fund (NYSE: JOF), which currently trades at a 3% discount.

Investors should do well with any one of those four funds.

Disclosure: None.

Disclaimer: The Oxford Club LLC/Investment U and Stansberry & Associates Investment Research are separate companies, and entirely distinct. Their only common thread is a shared parent company, Agora Inc. Agora Inc. was named in the suit by the SEC and was exonerated by the court, and thus dropped from the case. Stansberry & Associates was found civilly liable for a matter that dealt with one writer's report on a company. The action was not a criminal matter.