Despite a recent slowdown in emerging markets’ growth, they still present compelling opportunities for savvy investors as consumer spending is likely to increase by trillions of dollars in the decades to come. Clearly, with all the volatility in currencies and commodity prices, risks are there. However, each country has its own structural growth story due to the diversity of histories, geographies and economies of emerging markets, which could help override some of the cyclical volatility and create opportunities for investors to diversify the portfolio both geographically and within different consumer segments.
With their developing economies, expanding populations and rising incomes, emerging market countries are fueling global consumption and have a great deal of potential to grow even further in the long term perspective. Emerging market average GDP per capita amounts to USD 10,000, which is still a long way from USD 44,000 in the developed world and leaves some room for catching up.
In 1990, total consumer spending in the 12 largest emerging markets and 12 largest developed markets combined was USD 11 trillion, of which only 15% came from the emerging markets. 20 years later, total consumption nearly tripled, with emerging market consumption accounting for 26% of the total. By 2030, global consumption is estimated to be nearly USD 124 trillion, with over half expected to come from emerging markets.
Top 10 of 25 key emerging market economies with fastest annual real GDP growth: 2014–2015
Note: Emerging market economies cover 25 key countries that include Argentina, Brazil, Chile, China, Colombia, Egypt, Hungary, India, Indonesia, Kazakhstan, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Romania, Russia, Saudi Arabia, South Africa, Thailand, Turkey, UAE, Ukraine, and Vietnam.
Source: Euromonitor International from national statistics/Eurostat/OECD/UN/International / Monetary Fund (IMF), World Economic Outlook (WEO) in: 2015 Outlook for Emerging Market Economies, February 24, 2015.
Emerging middle class
Emerging markets enjoy a favorable demographic situation. Their young, fast-growing populations offer potential for long-term growth. With nearly 60% of the global population living in the emerging markets in 2015, the countries already represent a powerful consumer market. Furthermore, the rate of their population growth is estimated to be three times that of developed economies between 2013 and 2020. A combination of economic growth and rising population has led to a rapid expansion of the middle class. Now amounting to over one billion people, the emerging middle class is expected to double to more than two billion by 2020 and constitute around 70% of the world’s middle class. Significantly, this group of consumers will be enjoying ever-growing income and spending levels, giving thus rise to large consumer markets.
From commodities-driven to consumption-driven economies
As income per capita increases, the structure of demand changes. Economies move from building basic infrastructure to consumption-driven growth. Consumption itself then moves from consumer durables to discretionary products and services. The increasingly wealthy emerging market consumers end up with the same desires and aspirations as their developed world counterparts, creating structural growth opportunities in, for example, food and beverages, retail, travel and financial services.
Global emerging market countries are moving from an “age of commodities” to an “age of consumer durables
The greatest acceleration in consumption growth usually takes place at a GDP per capita level of USD 5,000 – USD 15,000. Most developing economies have either reached this level or are getting closer to doing so. Once the market for basic consumer products becomes saturated, new windows of opportunity appear, with the strongest potential in education, healthcare, banking, tourism, apparel etc. The structure of each emerging economy influences its employment patterns and income distribution. Therefore, each country will have its own areas of strong growth, for example, e-commerce in China, apparel in South-Africa, pharmaceuticals in Brazil and the food retail market in Russia. This means that correct sector allocation and stock-picking within the sectors will be crucial for investor performance.
M-commerce era for emerging consumers
Looking at the next wave of billion dollar consumption opportunities, mobile commerce (m-commerce) is likely to be one of the best structural growth stories.
Taking China as an example, affordable data connections, the proliferation of low-cost smart devices, and an enormous consumer base connected by social networks are all now in place, completing the m-commerce ecosystem. Since 2014, when 4G data services became available in China, China Mobile alone saw its 4G subscriber base grow and the run rate exceeded 17 million new users per month in the first quarter of 2015. By the end of the year it will likely reach 250 million. This trend coincides with falling prices for 4G handsets. Xiaomi, well known for its low cost smartphone brand, sold over 60 million handsets in 2014 and the company sees the potential to double the total shipment by units in 2015.
This marks the beginning of a new era for mobile-related consumption. O2O (online-to-offline) related consumption is growing exponentially and the potential is huge. The concept of using one application as an entry point to all everyday tasks has begun to take shape. Synergies with strategic e-commerce partners enable WeChat to encompass almost all consumption needs. Location-based search services, taxi and movie bookings, mobile payments and flash online sales are just a few of the opportunities.
Consumer stocks continue to drive emerging market performance
Last but not least, an increasing contribution of consumption to economic growth in emerging markets has historically translated into superior share price performance of emerging consumer stocks compared to the broad emerging equity market. This trend is expected to continue. Consumer stocks have significantly outperformed the benchmark, and over a ten-year period their annualized performance has reached 18.57% versus 10.68% of the benchmark.
Focus on structural growth stories
There are many reasons to believe that rapid growth in consumer spending in the developing world is a secular trend that will continue to spur global economic growth and corporate profits, and create a wealth of investment opportunities in both emerging and developed-market stocks. However, since the global emerging markets universe consists of a large number of countries with economic, cultural and political differences, investment opportunities will differ in each country at any given time. It is vital to invest in sectors and countries best positioned for reasonably valued growth. The emerging market consumer theme is a structural growth story where rising incomes are the most important driver. This structural growth can often override cyclical factors, making emerging market consumption growth an interesting long-term investment opportunity. Diversified and actively managed investment vehicles with investment managers capable of identifying multi-sector opportunities across this space will undoubtedly be one of the best ways to capture investment returns.
Russian consumer angle
Each emerging country has their specific structural growth areas depending on the history, structure of economy and other factors. In Russia the consumer story is easiest to play through modern retail. This is a perfect example of an area where the strong companies grow even in an environment of declining GDP. Three listed companies, Magnit (MCX:MGNT), Lenta Ltd (LONDON:LNTAq) and X5 Retail Group (LONDON:PJPq) are growing their sales by over 25% as they open new stores and grow their market shares. Valuations of these companies is at a significant discount to other emerging market peers due to the Russian equity market discount.
In 2014 most things went wrong for Russia. Ukrainian crisis, sanctions, oil price decline, ruble weakness and high interest rates. However, in 2015 all of these have started to move to the right direction. The equity market already took a leg up from the oversold levels. If the ruble and oil price remain stable and the economy finds a bottom during the summer we expect a second leg up from the stock market during the fall. If a market performs, it is difficult for investors to continue to stay away. Therefore, we would expect inflows to follow.