After spending two weeks in China and Turkey attending conferences and meeting with companies, I am more than ever convinced that the main theme for investors in the coming years will be the transition from a global economy led by the West to a global economy led by the East.
The current talk about a 'decoupling' between the developing and the developed countries is to some extent misleading. A severe recession in the United States would obviously have an impact on the developing countries. However, rising consumer and infrastructure spending and growing intra-regional trade will help these countries continue to experience rapid growth even if exports to the US were to fall significantly. One interesting factor that is often overlooked when analysing intra-regional trade is the growing integration between Asia, South America, Africa, the Middle East and Russia.
The next stage in the 'coming of age' of the developing world will be very different from the last decade, however. As James Kynge, Chairman of Pearson in China and author of the book 'China shakes the world' has argued, we are moving away from an environment of supply and abundance to one of demand and scarcity. The ability of the emerging countries, and especially China, to export disinflation to the Western world, is increasingly called into question due to rising labour and environmental costs and the governments' concern to provide more welfare protection for their populations. There is also the issue of rising food and energy prices, a direct consequence of the emergence of the developing countries. Amongst other things, they reinforce the current inflationary trends in the developing world and could convince the monetary authorities of these countries to undo the (more or less explicit) peg to the US dollar. This peg currently forces them to import the Federal Reserve's anti-recessionary monetary policy that no longer suits their economies.
How can an investor benefit from the transition to a world economy led by the East?
There is obviously the possibility of investing directly in the equity markets of the emerging countries, either through investment funds or individual stock picking. When it comes to stock picking, the rules that apply to Western markets also apply to emerging markets. Investors should have a long-term investment horizon and select companies that have a sustainable competitive advantage, are financially sound and not too expensive. As the leading trading and logistics firm linking East and West, Hong Kong based Li&Fung (*) is the quintessential globalisation company. India is becoming known as the 'back office of the world' and Infosys Technologies is one of India's leading software companies. TSMC (Taiwan Semiconductor Manufacturing Company) is the world's biggest independent maker of semiconductors. As the third largest cement producer worldwide, Cemex (Mexico) will benefit from the rise in infrastructure spending. Anadolu Efes is the largest brewer in Turkey with a market share of over 80% and a strong presence in Central Asia. It also has a dominant position in soft drinks through its 50.3% stake in Coca Cola Içecek.
As noted above, rising commodity prices are to a large extent linked to the emerging markets theme. The industrialisation of the developing countries, especially China, is fundamentally changing the supply/demand situation for many types of commodities. As a result, commodites producers that used to be disappointing long-term investments because of highly cyclical and erratic earnings, are now flourishing in a secular growth environment. The most interesting companies in this segment are often located in Brazil (which explains the growing trade links between Brazil and China) given the country's competitive advantages in terms of its natural resources. Vale and Aracruz are two high quality companies which are the lowest cost producers for a lot of commodities (metals in the case of Vale, pulp in the case of Aracruz). South Korea based Posco is one of the largest, most efficient and most profitable steel makers in the world.
Then there are the Western companies that are benefiting from rising consumer and infrastructure spending in the developing countries. In the past, globalisation meant that Western companies outsourced the manufacturing of their products to the developing countries and then sold these products in the developed markets. Now many of the developing countries have become the end markets. Personal consumption is finally taking off, but average purchasing power is still low compared to Western standards and wealth is usually highly concentrated in the urban centres. On the other hand, the number of very rich individuals is increasing. China, for example, has the second highest number of billionaires after the United States. In a very competitive environment, brands provide an edge as long as cultural differences are taken into consideration. In personal care, Procter&Gamble seems to have found a winning strategy through a mixture of very low-priced products for the rural areas and higher-priced products for the urban areas where purchasing power is higher. With brands like Cartier, Dunhill, Piaget and Chloë, Swiss luxury goods group Richemont is well positioned to capitalize on spending by the very rich. In its fiscal year 2008, Asia-Pacific already accounted for 48% of the group's sales growth. Nestle, owner of Nespresso, Perrier, San Pellegrino and Haeagen-Dazs amongst many others brands, should also benefit from rising discretionary consumer spending.
Equity returns can only come from two sources: rising earnings and/or higher valuations. Prudent investors should not count too much on higher valuations. It is therefore important to find companies that have the potential for strong and lasting earnings growth. Those that benefit from the rise of the developing world will at the very least enjoy a strong tailwind.
(*) Readers should note that the companies I refer to in this article are not investment recommendations.
