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Japan released two key economic indicators this week: Consumer price index data and international trade statistics. The basic summary is that Japan imported a lot more, but inflation wasn't one of those imports. Japanese equities have been attracting considerable interest; however, the economic backdrop is a critical piece in the investing puzzle.

Looking first at international trade, Japan recorded JPY 4,971.6 billion in exports, which was down 19% vs. December, and up only 1% against January 2010. Why? A key driver was China being on holiday, which can pretty much explain why Japan recorded a trade deficit (given imports were JPY 5,442.8 billion). Oh, and Japan last saw a trade deficit in January 2009. So what? Well, exports are still relatively strong despite the China factor, and imports are continuing an upward trajectory -- which is usually a positive sign for an economy.

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So the trade data was a little unusual, but the CPI data was more of the same. Japan saw 0% inflation in January ... and, for the inflation hawks, Japan recorded deflation of -1.3% in January 2010. If you applied the same increase to the U.S., then US inflation would be 3.8% instead of 1.6%. The point is, Japan is starting to see a trend of "dis-deflation." On a core basis, January deflation was -0.2% vs -0.4% in December 2010.

So what's the prognosis for Japan? International trade appears to be continuing to recover, both on exports and imports; inflation appears to be starting to show through; and unemployment is stabilizing if not falling.

But the real question is: Why would you invest in Japan when emerging markets offer better growth prospects (and for the most part, better demographics)? In the long term, Japan has significant challenges with debt and demographics, but in the medium term, Japan is in a similar situation to the U.S.: A little bit of inflation, a bit of economic recovery, and a lot of policy stimulus.

So conditions may well be there for developed markets like the U.S. and Japan to outperform emerging markets, simply for the fact that they don't need to tighten monetary policy (as has happened in China and Vietnam). What's more, on a valuation basis everyone is on the emerging markets bandwagon, but people are starting to see the developed markets case, and the valuations worm may be turning; will the fundamentals follow?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.