Japan's economic transformation: Are we there yet?

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Negative calls on Japan's market remain few and far between even after a nearly non-stop rally for more than two years, suggesting confidence in the economic revival may not be misplaced.

"Our overall assessment of the new growth strategy is now 'A-,' improved from the previous assessment of 'B+,'" Societe Generale said in note earlier this month. "Japan has entered a positive economic cycle."

The has rallied -- nearly doubling since the beginning of 2013 and up nearly 17 percent so far this year -- despite doubts over whether Abenomics, or Prime Minister Shinzo Abe's plan to kick start Japan's economy out of its decades-long deflationary slump, would see any success.

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Much of the rally had been driven by the first "arrow" of Abenomics -- a massive quantitative easing program from the Bank of Japan, which sent the yen sharply lower and boosted interest in stocks. The "second arrow" was meant to be fiscal stimulus. Some analysts had grown weary of waiting for promised structural reforms, dubbed the "third arrow" of Abenomics, but there are some sign those are taking flight.

"Structural reforms are difficult to implement and they take even longer to come into fruition, to show the results. But the third arrow has been fired," Lim Say Boon, chief investment officer at DBS Wealth Management, said at a presentation to clients last week. "We've seen the blueprints for corporate tax cuts, agricultural liberalization, deregulation of a whole range of areas: energy, environment, health care. We have seen a new corporate governance code and we have seen plans for tax incentives to raise female participation in the work force."

Lim also sees signs wage growth is at an early stage of improvement, which, if sustained, could help boost consumption growth in the future . DBS, which went overweight on Japan stocks in 2012, is sticking with its call.

DBS isn't alone. Global investors are a net 37 percent overweight on Japan stocks, according to the Bank of America Merrill Lynch global fund manager survey for July. Japan ranks second, after Europe, for the market investors most want to be overweight, the survey found, with a net 70 percent of Japan equity specialists saying the economy is improving.

Not everyone is gung-ho, though, about pushing money into Japan investments.

Temasek, Singapore's $196 billion sovereign wealth fund, has no direct exposure to Japan, despite having "transforming economies" as one of its four key investment themes.

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"We continue to look at Japan and opportunities in Japan," Ravi Lambah, senior managing director for investments at Temasek, said at the press conference last week announcing the fund's results. "For us to make an investment, it has to fit the criteria and what we look at."

One headwind to buying companies in Japan may be the expense of competing with potential homegrown buyers with buckets of cash sitting on their balance sheets. With Japan's bond yields likely to remain stuck at lows, the bar for returns on acquisitions is set fairly low.

That may have been a driver behind Japan Post's acquisition of Australian freight player Toll Holdings in February. Analysts said the nearly 50 percent premium Japan Post shelled out for Toll was excessive, but Toll's around 4.8 percent pre-offer dividend yield may still have looked juicy compared with the yield offered on the 10-year Japanese government bond, currently around 0.46 percent.

Concerns about the expense of investing in Japan have dampened interest in the stock market somewhat.

"From a valuation perspective, Japanese equities are trading at 17 times and 16.5 times price-to-earnings based on FY2015 and FY2016 earnings forecasts – both at the high end of the global equity market valuation range," Toru Ibayashi, head of Japan equity at UBS wealth management, said in a July strategy note. "We do not see the market's current valuation as being cheap," he added, noting UBS is staying neutral.

Ibayashi also isn't terribly optimistic on the outlook for the country's reforms.

"We like the solid earnings growth prospect, but this is driven by a weaker yen and a one-off corporate tax cut in 2015," he said. "In the absence of enduring reforms, and since we do not expect the yen to weaken much more in the next 12 months, earnings growth could slow substantially in FY2016."

Ibayashi may not have much company in concerns over valuation. Most global investors believe Japan shares are undervalued, with a net negative-11 percent saying they're overpriced, with around 80 percent expecting corporate earnings to improve by double-digits, the Bank of America Merrill Lynch fund manager survey found.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1