- Japan's stock market rally braces for Abe's economic reforms test
* Foreign investors want to see next stage of 'Abenomics'
* Further economic reforms needed to convince doubters
* Stock market rally risks stalling if Abe disappoints
TOKYO, Sept 12 (Reuters) - A breakneck stock market rally in Japan, the best by far in the developed world this year, risks stalling as doubts emerge among foreign investors that Prime Minister Shinzo Abe can embark on bold economic reforms to underwrite sustainable long-term growth.
The issue for many foreign fund managers is whether Abe will be able to deliver crucial structural reforms to compliment his fiscal and monetary expansionary policies that's driven an eutrophic rise in stocks and provided fresh impetus to the world's third-largest economy.
The benchmark Nikkei is up 40 percent so far this year, the top performer among major developed markets in local currency terms. In comparison, the U.S. S&P index is up 18.4 percent in the same period, while Europe's FTSEurofirst 300 is up 10 percent.
Other bright spots include an uptick in capital spending, consumer confidence and easing deflation pressures. Data this week showed Japan's economy grew at a much faster pace than initially expected in the second quarter, comfortably outstripping its peers in the developed world.
Still, investors remember only too well the excruciating memories of the past. Many of them were burnt in the last two decades as stock market rallies fizzled on disappointment that Japanese politicians had failed to follow through with painful but necessary restructuring.
As the markets await Abe's final green light on a two-stage sales tax increase and other reform details, foreign investors are looking to lock in profits on outperformers and put some of their money into laggards.
A case in point is the recent surge in the number of foreign fund managers attending brokerage seminars as they search for undervalued stocks or new investment ideas.
The number of overseas money managers at a four-day conference at an upscale hotel in Tokyo organised by Mizuho Securities doubled to 320 from the previous event in February.
Robert Taylor, a portfolio manager at Harris Associates L.P. in Chicago with $20 billion under management, was among them.
"Abe-san really hasn't done anything yet. All he has done was quantitative easing. Nothing fundamental really has changed," Taylor said. "As share prices reflect more positive sentiment, things are not as attractively priced to us, so we want to decrease our weight."
"As things get close to the fair value, the chance of losing money in that (stock) name goes up so it becomes more risky and so we want to reduce that risk by trimming the position and adding more undervalued names."
If Abe decides to proceed as scheduled, the sales tax will rise to 8 percent from 5 percent on April 1, and to 10 percent in October 2015, as part of the plan to restore the fiscal health of Japan, which has a debt level of more than twice the size of its economy - the highest in the developed world.
However, Abe who swept into office in December elections with a vow to unleash the most serious attempt in years to snuff out Japan's grinding deflation, is treading cautiously.
Many politicians blame the last tax increase, in 1997, for plunging the country into recession, but a recent run of positive data has bolstered the view that the economy can withstand the pain from a tax hike.
Apart from the tax-hike plan, investors are also keenly aware of other reforms that the government will need to tackle over the next year to spur long term economic growth.
Indeed, in June markets sold off after Abe unveiled an underwhelming package of long-term growth plans.
Immigration has long been a sensitive and thorny subject. Japanese politicians of the past have lacked the political will to address the issue even though the nation's greying population - the highest proportion of total population in the developed world - puts a big burden on the economy.
"We discovered that Abenomics doesn't address the main issue of Japan, which is demographics. Immigration is the key factor to change the view of long-term investors," said Joel Le Saux, senior portfolio manager at SYZ Asset Management SA in Geneva.
But he also said the value of his fund, worth $230 million as of now, has increased 90 percent since February as his clients, who are based in continental Europe, have increased investment into Japanese shares.
Nonetheless, overseas money can leave Japan as quickly as they have arrived if Abe were to disappoint with his reform push, giving foreign investors another sour taste.
Foreign investors sold 1.93 billion yen ($19.3 million) of Japanese equities last month after they had ploughed 9.75 trillion yen into the country in the first seven month of this year, the highest for the period since Japan's finance ministry started collecting records in 2005.
"Japan is at the dawn of an inflection in terms of its economic policy, and I think if this plays out, it will be tremendous success for Japan," said Cedric Lecamp, senior investment manager of PAM equities at Pictet Asset Management SA in Geneva.
($1 = 99.9850 Japanese yen)
(Editing by Dominic Lau & Shri Navaratnam)