Consumption in emerging markets is growing, but investors exploring that arena need to understand the types of consumption, what drives it and the cyclical highs and lows these markets go through.
“This is massive, this is huge,” said Joe Faraday, investment manager with Baillie Gifford Investment Management, speaking during Benefits Canada’s annual Benefits & Pension Summit in Toronto. More than half of the business multinational companies see comes from emerging markets, he explained, adding that this consumption will keep growing because this is just the beginning. “Give it another few years, and China will surpass the U.S. in terms of consumption.”
While the citizens of emerging economies are buying more, Faraday cautioned that investors shouldn’t lump all of these countries together because they are different. “It’s quite a dangerous topic to generalize about. […] Let’s look at individual countries.”
A stove in the kitchen?
Emerging markets fall into three categories in terms of consumption, according to Faraday.
The first group includes nations such as Nigeria, India, the Philippines and Indonesia. Those countries consume basic necessities, and this is where you may find a stove in people’s kitchens.
The second group includes economies such as Thailand, Brazil, Turkey and China—countries where you can find a microwave in the kitchen. This group consumes items that include cars, motorcycles and fast food.
The third group is made up of countries such as Russia, Korea, Poland and Taiwan. Their citizens are very likely to have fully equipped kitchens with a dishwasher. They buy luxury items such as gaming consoles and air travel.
Drivers of consumption
Four factors drive consumption in all of these markets: people, purchasing power, the adoption of high-tech items by society and government policy, Faraday explained.
For example, urbanization is a key aspect of the people factor. Once an Indian farmer moves tot he city and starts working in a factory, he has more money to spend. China is also experiencing the same phenomenon. “China has more than twice as many large cities than there are in North America today,” said Faraday. “This is a massive driver of growth.”
Another aspect of the people factor is the so-called youth bulge—but that trend has some downsides, too. “It’s very, very powerful, unless those people have no money,” said Duncan Artus, portfolio manager and director with Allan Gray Proprietary Ltd., speaking at the same conference. If young people are unemployed, they may not necessarily be “a future consumer of Nestle products” but they’re likely to be a political and social risk, Artus explained.
What to invest in
Mobile phone penetration is one of the biggest trends in emerging market consumption, Artus said. “This is a very, very powerful trend. If you’re able to find a mobile operator that’s No. 1 or No. 2 in the country, that’s good, invest in it.” But Artus cautioned that once a nation’s mobile phone market matures, new competition and government regulations emerge—much like in the developed world. That’s when investors’ profits start to come under pressure, he explained.
The Internet is another strong emerging market trend that investors can take advantage of, according to Artus. But “even if you knew the Internet is a powerful trend, it’s tricky to benefit from it,” he said, explaining that in China, for example, Internet companies make money specifically from online gaming—something that may not be obvious.
Ups and downs
Another thing investors need to keep in mind is that there are cycles of highs and lows when it comes to consumer growth in emerging markets.
At the beginning of a typical cycle, consumption is growing, the national currency strengthens, interest rates come down, credit becomes more available, and all that attracts more money to the market. But at this time, the country also starts to import a lot, which means that the current account and fiscal deficits also grow and the government starts to borrow more money. “All of a sudden the party stops,” the money leaves the country and the cycle reverses, Artus explained.
It is also important to understand that there’s no correlation between economic expansion and returns, according to Artus. “There is no certainty that if GDP grows faster, you will get higher equity returns,” he explained.
All the articles from the event can be found on our special section: 2014 Benefits & Pension Summit Coverage.
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