Is Japan a share bargain too good to ignore?

The past 20 years have not been great for investors, but things may be on the up

Few things are more irritating than finding that perfect bargain item only to see it has become even cheaper the next day. Buying Japanese shares over the past 20 years has been a similar story and has certainly not been for the faint-hearted, with investors nursing significant losses this year alone.

But at such a cheap price compared with the rest of the world, it might be worth asking whether Japan is a bargain too good to ignore and is it ready to make a comeback?

"It's almost become a badge of honour to say 'I've had nothing in Japanese equities' – because it's been disastrous for more than 20 years," says Tom Becket at PSigma Investment Management. "But I think the Japanese equity market could double from where we are now: It could go from around 10,000 to 20,000 in three to four years."

There are certainly a few arguments in favour of Japanese equities. Not only are they cheap, but they offer attractive yields – higher than government bonds and US equities – and are distinctly under-owned, even widely hated.

And if the market does start to rise, it could surge rapidly as people pile in to ride the wave. So why, then, has buying Japan not come good and how has the market managed to see two lost decades?

"It's been fighting against deflation for 20 years, which has been an issue," says John Husselbee at North Investment Partners. "They have poor demographics versus the rest of the world," he adds, pointing to the country's extremely high proportion of elderly citizens.

"But the real challenge is the strength of the yen," says Mr Husselbee. "The yen is a threat to the profitability of exporters. So the Bank of Japan has tried to weaken it." At some point, though, the tide will turn and the yen weaken. When this happens, the pressure will be released on Japanese stocks, allowing them to rise. But calling when this will happen is anyone's guess.

Another stumbling block for the country is that the government owes a lot of money, but the people who hold a large chunk of the debt are Japanese residents. "There needs to be a transfer of wealth from the populous to the government," says Rob Morgan at Hargreaves Lansdown. "But how that happens when the political framework doesn't work that well is debatable."

So what would it take for a turnaround? "It could be a slow chipping away of problems – it might not be immediate," says Mr Morgan. "It will take renewed interest from international and domestic investors and it's a bad sign that the locals are content with bonds – it looks as if they aren't interested in equities."

Growth in Europe and the US would be a large factor that could help ignite the Japanese market, as investors' confidence starts to return. But you could buy now as the market is about the cheapest it's ever been, though don't hold your breath. "It's for the long term," says Rob Burdett at Thames River Capital. "There may be something around the corner, but it's harder to see a catalyst there than in other parts of the world."

But even if it seems prospects for Japan are attractive, the investment is not without risks and is perhaps more suited to the intrepid investor. "Japan is really a high-risk sector and therefore should be kept to less than 10 per cent of your equity portfolio, as an absolute maximum," warns Philippa Gee of Philippa Gee Wealth Management. "There is also such uncertainty over whether Japan will regain its position of strength, to the point that some fund managers have totally written off the sector as a core investment approach," she says.

Despite the risk the market isn't going anywhere any time soon. Be prepared to hold on to a bargain, as it could be a while before its value grows.

Emma Dunkley is a reporter for citywire.co.uk