With innovation driving equity gains in Japan, Shuntaro Takeuchi, Lead Manager of the Matthews Japan Strategy, remains constructive on the long-term growth potential of Japan's markets.

Q: What sectors and themes do you favor in Japan?

As active investors, we search for opportunities in innovative technology and services, which naturally leads us to the broader technology and health care sectors. Two major themes that we continue to monitor are labor productivity improvements and combating rising health care costs.

Labor populations are peaking in the U.S. and China as the world begins facing issues that Japan has been facing over the last few decades. Baby boomers are nearing 70 years old and birth rates remain at record lows in almost all advanced economies. When you ask which companies have thrived amid a steady decline in labor force, aging society, low birth rates, shrinking domestic demand and deflationary environment, the answer is growth companies in Japan. They have provided solutions to these structural challenges. Successful Japanese growth companies now have the opportunity to grow outside of Japan as these trends are starting to be felt globally.

Q: Japan's broader markets continue to lag U.S. equities. Why has sentiment been weak?

Regarding weak sentiment, we're still in one of the deepest recessions ever. More than half of Japanese corporate profits come from export sectors, which have a high correlation to the global manufacturing Purchase Managers' Index. June quarter earnings results showed some resilience compared to consensus estimates, but at the end of the day, operating profits are still down steeply year-over-year. We do seem, however, to have seen the worst: Month-over-month numbers are slowly improving.

While COVID-19 cases in Japan have been lower than in other developed economies, strict protocols remain in place throughout the country, which could continue to have a dampening effect on the domestic economy in the near term. On a long-term view, however, we remain very constructive on investments in Japanese growth equities.