The Emerging Market Century

Coverage of the 2011 Global Investment Conference.

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shanghai skyline chinaEmerging markets have dominated both headlines and investment theses of global managers in recent years. With secular trends still favoring emerging economies, they will remain top investment themes while increasing their weight in world markets. However, recent events in the Middle East demonstrated the ever-present impact of geopolitical risk. We are still in the early days of industrializing the emerging world.

Historical experience suggests a strong correlation between labor force growth and economic growth. Demographic trends will decidedly favor emerging countries relative to the developed world over the next 30 years. The ensuing GDP growth will increase the economic influence of emerging markets. Projections show the emerging share of global GDP surpassing the developed market share within five years. Additionally, China’s projected nominal GDP is expected to surpass the U.S. in 2010, with India following suit in 2025. With this exponential growth comes the need to expand the funding structures, resulting in increased IPO activity. The U.S. and Western Europe accounted for only 26% of IPOs by market value in 2010. Emerging market companies are also gaining the potential to be acquirers of companies in both developed and emerging markets.

With industrial production the primary driver of hard commodity demand, rapid growth in emerging economies will continue to lead global demand for commodities and raw inputs. Today, China is the key determinant of commodity prices as the major buyer of most resources; however, other emerging markets are expected to play a more significant role in the future.

Rapid wealth creation in the emerging markets will also boost consumer demand for higher quality foodstuffs, such as meat, fruits, and vegetables, and for middle-class aspirational goods such as cars and vacation travel. The total number of households in the BRIC countries with disposable income of over US$10,000 has already surpassed the U.S. and euro area and is projected to reach 500 million households by 2019. By 2014, World Bank estimates show Malaysia, Thailand, and China as having half of their populations in the middle class, continuing to fuel demand for consumer products. More than twice as many cars are sold annually in emerging countries than in the U.S., but disposable income per capita is only a fraction of the U.S. levels. As the prospect of rising disposable income materializes, the opportunity for increased sales of cars in BRIC countries as well as Indonesia, the Philippines, and Pakistan projects a strong growth trend.

Meanwhile, technology use is growing rapidly and the percentage of internet users is rising steadily. PC sales in China are forecasted to surpass those in the U.S. in 2011. While internet users as a share of the population is leveling off in the U.S. and Japan, areas such as Indonesia and India are showing signs of steady growth, while in China it has risen from 10% in 2006 to an estimated 50% in 2011. China has already become the largest cell phone market in the world.

Despite these supportive trends, risks remain. Rising inflation and tighter monetary policy have contributed to under-performance relative to the developed world over the past few months. Political upheavals in Tunisia and Egypt and the interruption to global oil supply caused by the revolution in Libya are stark reminders to investors that geopolitical tensions are episodic and will periodically flare up. Other risks include unemployment, global pressure due to human right abuses, and a lack of purchasing power if wages fail to keep pace with inflation. Still, in our opinion, the secular trends remain too powerful to ignore. The long-term benefits of investing in emerging markets far outstrip the potential risks for a prudent, long-term investor.

Scott Berg, Portfolio Manager, Global Large-Cap Strategy.

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