The U.S. and Eurozone economies are going gangbusters.

If you compare them to Japan’s stock market, that is…

Last Friday, the Eurozone’s first-quarter GDP report showed a record 2.5% contraction, punctuated by Germany’s 3.8% drop. It was the country’s worst quarterly performance since 1970 and over the past three quarters, Germany has erased all its gains made since 2005.

But Japan managed to trump both of them today, announcing a 4% quarterly drop. Its fourth straight three-month retreat equated to a 15.2% annualized plunge and in the fiscal year to March 31, GDP fell by 3.5% – the worst since 1955.

While the performance came as little surprise, the fact that it wasn’t as bad as the estimated 16.1% drop brought some bold comments from economists. Both Richard Jerram, chief economist at Macquarie Capital Securities in Tokyo and Jesper Koll, CEO of the TRJ Tantallon Research hedge fund in Japan called the results a “bottom” for the Japanese economy and that the recovery is underway.

And Goldman Sachs’ (NYSE: GS) chief Japanese economist calls for a positive GDP reading in the current, with the rate rising to 3% during the third quarter.

Are they right?

Japan’s Stock Market – A Harrowing Quarter

In the midst of a brutal period, Japanese giants like Sony, Toyota, Panasonic, and Hitachi may be surprised to hear such bullish comments regarding their stock market.

The U.S. financial crisis, ensuing credit crunch, and global recession have crippled demand for goods and forced both firms to curtail production and lay off workers.

And they’re not the only ones. Driving Japan’s record-setting first quarter was a 26% tumble in exports from the fourth quarter, while business investment and consumer spending also dropped by 10.4% (a record) and 1.1% respectively.

Weak demand from the Japanese themselves amid a rising jobless rate accounted for 2.6% of the GDP drop – the most since 1974.

So why the optimism amid these awful figures?

Land Of The Rising Stimulus: A $150 Billion Fix

How do you fix a broken economy?

Forget free market forces… just toss money at the problem.

In Japan, that fix amounted to the government giving every citizen 12,000 yen ($124) in March. Cost: $20 billion.

And last month, the government followed that up with the announcement of a $150 billion economic stimulus package. It’s designed to boost consumer spending by offering incentives to buy more energy-efficient cars and household appliances. The capital injection is also aimed at bolstering small businesses and sparking the job market.

While the jury may be out on U.S. stimulus efforts, current polls in Japan suggest the public is largely in favor of the measures. Despite the country’s woes, consumer confidence climbed to a 10-month high in April, as the government’s spending program was announced.

It also came on the back of a report that showed that factory production climbed by 1.6% in March – the first rise since September, with the trend projected to continue for April and May. That was in addition to exports edging higher in March, too.

The hope is that once the stimulus measures kick in, Japan will begin its long recovery by growing for the first time in a year during the current quarter. The government says it should add 2% to GDP growth this fiscal year, but skeptics wonder if the economy can sustain any momentum into 2010, as the stimulus effects wear off.

And of course, Japan’s various economic stimulus efforts over the past 20 years haven’t come cheap. The country is one of the most debt-ridden countries in the world, with its government owing almost $8 trillion.

But throughout all these recent economic pressures, one market has bucked the trend…

Japan’s Stock Market: Cheap And On The Rebound

Since hitting a low of 7,021 on March 10, the Nikkei 225 Japanese stock market has surged 33% to today’s closing price of 9,344.

In a similar way that U.S. investors have recently jumped on interest rate cuts and stimulus packages to gobble up quality stocks at a discount, so too have the Japanese.

In fact, Japanese stocks are the cheapest they’ve been since the early 1980s.

As we’ve said consistently here, it’s often the best time to buy a market/stock when everyone hates it and is ignoring it. That’s been the case for Japanese stocks.

In addition, stock markets are often leading indicators of economic activity. So given the Nikkei’s rebound since mid March, if the broader Japanese economy truly did bottom out during the first quarter and is set to head higher again (albeit fueled largely by government stimulus), you could attempt a short-term speculative investment while the stimulus measures work through the economy.

The easiest (and safest) way to do it is through a very liquid ETF that tracks the price and yield performance of Japanese stocks like the iShares MSCI Japan Index (NYSE: EWJ). It trades like a stock on the NYSE and offers a lower risk, lower cost way to diversify your portfolio.

The fund also has options available. This could be a better way to play it, given the volatility of the global economy and stock markets in general, not to mention Japan’s still-uncertain economy. You could hedge your risk by buying put options in addition to a stock play, or by executing a straddle or strangle play on the fund.

Martin Denholm
Smart Profits Report