Investors should maintain a positive long-term outlook on Japanese equities, according to some professional fund buyers, who believe attractive valuations and negative investor sentiment means there is plenty of upside potential.
Some economists, however, warned Japan's risk balance is "skewed to the downside", with the coronavirus outbreak likely to further bruise its already-fragile economy.
Figures released by Reuters last Monday showed Japan's GDP shrank by 6.3% during Q4 2019 - its fastest contraction since Q2 2014 when a tax hike bruised the consumer sector.
According to the data, capital expenditure in Japan fell by 3.7% during the last financial quarter - more than double the projected fall of 1.6%.
Reasons cited for the contraction include another sales tax hike in October and an uncharacteristically warm summer, which weighed on demand for winter items.
Economists are now predicting a further fall in GDP during Q1 2020 following the coronavirus outbreak, which would lead Japan's economy into a technical recession.
Taro Saito, executive researcher at NLI Research Institute, told the press last week (17 February): "There is a pretty good chance the economy will suffer another contraction between January and March.
"The virus will mainly hit inbound tourism and exports, but could also weigh on domestic consumption quite a lot.
"If this epidemic is not contained by the time of the Tokyo Olympic Games, the damage to the economy will be huge."
According to research from Capital Economics, disruption to supply chains and a slump in tourist arrivals caused by the coronavirus outbreak will likely knock 0.4% off of Japan's GDP growth during Q1 this year.
"As long as disruptions to supply chains and goods exports are short lived, the impact on Japan's industry should be small. But there is a growing risk the domestic outbreak will dampen consumer spending," it said.
"The biggest unknown is whether the crisis will result in a major drop in spending by Japanese consumers."
According to the research firm, the 2003 SARS outbreak resulted in a 7% drop in domestic tourist spending but had "no discernible impact" on retail spending.
"However, Japan had no domestic cases of SARS whereas there are now 520 known coronavirus cases in the country, including 454 that originated on a cruise ship stranded off Yokohama," it warned.
"As such, the 2% quarter-on-quarter plunge in Hong Kong's private consumption during the SARS episode provides a stern warning."
Capital Economics now expects Japan's GDP to fall by 0.5% in 2020 overall, compared to its previous estimate of a 0.2% drop.
"There is clearly a risk that Japan slides into recession at the start of this year," it added.
Silvia Dall'Angelo, senior economist at Federated Hermes, pointed out Japan's GDP is currently up by only 5% compared to its pre-2008 Global Financial Crisis levels.
She said that, because of Japan's structural issues - such as its ageing population and low productivity growth - and the fact it has experienced decades of extreme stagflation, deflation and low interest rates, it is particularly vulnerable to both domestic and external shocks.
"Looking ahead, the balance of risks to the outlook is still skewed to the downside. In the short term, the coronavirus epidemic is set to drag significantly on Asian output, meaning that Japan's growth is unlikely to bounce back significantly in Q1 from its Q4 setback," she explained.
"More importantly, protectionist tensions could well re-surface over the course of the year, meaning that, in absence of significant fiscal stimulus, the much-anticipated recovery in Japanese growth could be delayed indefinitely."
Between market close on Friday 14 February, and when the Q1 GDP figures were released at 10am on Monday 16 January, the Nikkei 225 index fell by 276 points - or 1.7% - to 23,402.42.
Year-to-date, however, the Nikkei has broadly flatlined with a 92 basis-point return at time of writing.
Tom Becket, chief investment officer at Punter Southall Wealth, said that while recent GDP data from Japan is "miserable" and the outlook for Asian and global trade is "becoming murkier", Japanese equities are "not a strong economic play".
"They are instead an investment in undervalued assets and underestimated corporate change. It remains noteworthy how unloved and underappreciated Japanese equities are," he said.
"We think we are fully justified in our overweight stance on Japanese equities and that they will be a powerful catch up trade in the coming years.
"Our research suggests Japanese equities are cheap and both macroeconomic fundamentals and corporate reform should be supportive of Japanese equity outperformance in the coming quarters and - in the case of corporate governance reform - years."
David Hambidge, director of multi-asset funds at Premier Miton, agrees with Becket, and has retained an overweight allocation to Japan for some time, with no significant changes over the last few months.
"Following corporate reforms over the past few years, companies are now much more shareholder friendly and continue to return surplus cash to investors by way of dividends and share buybacks," he said.
Kelly Prior, investment manager in the BMO multi-manager team, said the team has reduced its weighting to Japanese equities from overweight to neutral over recent months.
However, while she pointed out that the last year "has not been kind to Japan" following Typhoon Hagibis, a rise in consumer goods tax and the outbreak of the coronavirus, the investment manager said there is "as much scope for Japanese companies to make gains for shareholders as any".
"We invest in funds that invest in companies, not economies - though there are of course links between the two," Prior explained.
"We continue to like the Eastspring Japan Dynamic fund. A less well known but equally interesting holding for us is the Four Seasons Alpha Max Japan fund."
Hambidge and his team have held Lindsell Train Japanese Equity, Man GLG Japan Core Alpha, Coupland Cardiff Japan Income & Growth and Eastspring Japan Smaller Companies "for a number of years".
He added: "By blending these funds we have achieved superior returns to the index (TOPIX)."
Becket favours the RWC Nissay Japan Focus fund, which has been headed up by Yasuaki Kinoshita since 2015, and aims to invest in a small number of companies with strong potential for improvement.
"I am very much of the view now that Japanese equities will be an alpha rather than a beta play, with the winners rewarded and the losers drifting into obscurity through both operational and share price underperformance," he said.
"However, the fact most investors still ignore Japan gives us confidence that the positive view we have held since 2011 can continue to deliver good returns for our clients in the years ahead."