With all this positive data, how can investors tap into this growth trend?
In our opinion, Japan's indexes do not effectively capture the growth areas on the horizon. The Nikkei 225 is a price-weighted index, a design that is not very fundamental in nature, and the TOPIX is a product of more than 2,000 stocks, so the secular growth stocks typically get lower weights despite having high return potential.
Instead, investors should be active in Japan. It will allow them to be more focused within the diverse market and identify differentiated, high-growth areas in Japan to generate excess returns.
Two stable, long-term growth areas include the electrification of automobiles and industrial automation.
Japan has been famous for its car manufacturers, which form a big part of the index. But we are less bullish on them, because we feel the auto volume growth will be slow over the next few years. However, cars are becoming more sophisticated and will eventually be driverless. Electronic features in cars that were optional are increasingly becoming standard. The proportion of cost of electronic components in a car is expected to rise to 50% by 2050 from 22% in 2000. We prefer companies having exposure to these segments, as we expect the growth in these areas to be faster than the overall auto market growth.
At the same time, we also expect industrial automation to accelerate over the coming years because of aging populations in developed countries and the need for productivity improvement, and rising wages globally. Robot penetration in China, the world's primary manufacturer, is just three per 1,000 manufacturing employees, a level equivalent to Japan 30 years ago. As a result, the demand for industrial robots is expected to grow at an annual rate of around 14% until 2020. We are bullish on Japanese companies that manufacture sophisticated, high-quality components for industrial robots.
As corporate earnings continue to grow, strong fundamentals hold and corporate governance increasingly favors shareholders, we think portfolios will benefit from Japanese exposure. It's a deeper story than the traditional indexes are telling, but as investors take a closer look and recognize long-term growth areas, Japan appears to be on the cusp of a new growth wave.