In praise of emerging markets

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This post is a guest contribution by John Derrick, Director of Research at US Global Investors.

We believe global growth is the most powerful investment theme now and for the foreseeable future. You can see this playing out as countries like China, India and Brazil grow in economic stature. As we saw in Pittsburgh last week, the G-7 is being supplanted by the more inclusive G-20 when it comes to global economic decision-making.

Emerging market stocks were hit especially hard during the financial crisis but have been among the best performers during the rebound. We are currently in the midst of a synchronized global recovery, and with aggressive government stimulus, strong balance sheets and an ever-growing share of global GDP, emerging markets are likely to outperform the developed markets due to strong domestic consumption and forward-looking infrastructure investments.

The chart below from Goldman Sachs on consumer spending illustrates that point.

031009a

Goldman estimates that consumer spending in China will increase by about 10 percent in 2010, while India and Brazil will be in the 4 percent to 6 percent range. At the same time, negative growth is expected in Spain, Britain and Italy, and the forecast for the United States is flat. Industrial production in emerging markets has recovered to roughly where it was when the recession began; in developed markets, IP is still down nearly 20 percent.

This second chart, also from Goldman Sachs, compares the operating margins in developed and emerging markets for the companies in Europe’s Dow Jones Stoxx 600 Index. The analysis going back to the early 1990s found that the emerging-market operations of these companies have consistently yielded higher margins, and oftentimes the spreads have been significant.

031009b

US Global Investors recently hosted a global outlook webcast that featured Dr. Marc Faber, the well-known investor based in Hong Kong. In the course of that webcast, Dr. Faber addressed the developed-versus-emerging issue:

If you look at the next 10 to 20 years in the West, I don’t see how the lifestyle of the average person will improve meaningfully. On the other hand, if you look at a country like Vietnam, they have a GDP per capita annually of $800 which may go to $3,000 over the next 15-20 years.

The same is true for China and India. You suddenly have a middle class of 230 million people in India who will be buying cars like the $2,500 Nano and other goods.

Once a family moves from the bicycle to the motorcycle, it’s an improvement in their standard of living. But when you move to the car and drive your children to school in your car, it’s a huge increase in your standard of living and your social class.

Global growth has been a tremendous benefit for commodities, with the key driver being strong demand from China. And as we pointed out in a recent webcast focused on China, that use of commodities is less to fuel export growth and more to satisfy domestic demand as income levels rise. Increasing demand for commodities and the corresponding rise in prices has positive knock-on effects for much of the developing world.

The increasing importance of emerging countries in the world order also argues for their currencies to strengthen relative to the dollar. International stock markets outperformed the US market during the 1970s and much of the 1980s, with much of that outperformance relating to relative currency strength.

A continuation of the dollar’s decline in the face of slow growth and yawning budget deficits – nearly $11 trillion between 2009 and 2019, according to White House estimates – would provide a significant tailwind for globally-minded investors.

Source: John Derrick, US Global Investors – Investor Alert, October 2, 2009.

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