Investing across the global growth gap

Governments and central banks around the world responded to last winter’s global financial crisis with unprecedented fiscal stimuli and monetary easing. The result by this fall has been an extraordinary, synchronized global economic upturn — but one that remains strikingly uneven. Developed economies showed signs of slowly recovering by the end of this summer, but many developing nations had actually recovered much earlier and much faster.

This sizable global growth gap will not only persist but also likely widen, presenting diverse opportunities for investing all over the world. And as the world emerges from the worst global economic and financial downturn since the 1930s, the case for investing across this global growth gap is compelling.

Earlier this year, the Chinese economy was the only one of the world’s 10 largest that was growing, suggesting that this global recovery may be the first in which Asia — not the United States — leads the way. With such a fast economic rebound, strong market performance and perhaps unrealistic expectations for emerging markets, caution is in order. Emerging markets’ strong economic growth should lead companies and markets upward in the long run, but short-run correlations are much less certain.

Still, the fundamentals of emerging markets remain very attractive. Developed markets will eventually resume an expansionary trend, but the likelihood remains that emerging-markets growth will account for an increased share of global economic growth, perhaps as much as two-thirds. As last year’s steep decline in emerging markets indicates, their historical volatility and perceived risk linger. But many of these economies went into last year’s market collapse in much stronger shape than the developed world — with current-account surpluses, much higher savings rates, less leverage and relative insulation from global banking problems.

For emerging markets, the demographic case alone is powerful.

Developing nations have a float-adjusted market capitalization representing only about 12% of global float-adjusted stock capitalization, but they hold 87% of the world’s population, 68% of its foreign reserves and a potential work force and consumer base much larger than that of the developed world. Of all global growth these days, 22% is coming from China alone, 37% from emerging Asia including China — and only 15% from the United States.

Every region and country is different. But across the emerging-markets universe, return on capital is higher than in developed markets, banking systems are healthier, and consumers and corporations are less indebted. Despite what happened to emerging-markets stocks in 2008, when investors fled all asset classes that were perceived as potentially risky, the fundamentals of emerging markets are better than those of developed markets. If you liked emerging markets from 2005 to 2007, that story hasn’t changed.

While attractive investment opportunities can be found across the emerging-markets landscape, much revolves around China. But Chinese stocks have run hard, and the question now is to what extent has there been an inventory-restocking cycle that steals from longer-term growth. Do we hit an air pocket in China until demand gets better footing?

At the moment, certain other emerging markets — particularly India and Brazil — may present equal or better prospects than China does. Nevertheless, we remain optimistic about Chinese equities in the long term. Our base case is that the global economy is slowly recovering, and therefore exports should rejoin consumption and infrastructure in supporting Chinese growth.

At the same time, it has become less necessary for U.S. investors to look abroad to invest in emerging markets. Forty percent of the revenue of companies in the S&P 500 now comes from outside the United States, up from 32% in 2002. The energy, technology and consumer-staples sectors all derive more than 50% of their revenue from overseas.

Facing the challenge of maintaining earnings growth, many companies based in developed nations are increasingly targeting growth in emerging markets.

The United States is a leader in technology, health care and financial services, and these sectors present opportunities to profit globally. In screening U.S.-based companies for growth prospects, you’re led to those that have important operations in emerging markets. This is a secular trend from which U.S. investors can profit abroad and at home.

Scott Berg is portfolio manager of the T. Rowe Price Global Large-Cap Equity Fund.

For archived columns, go to investmentnews.com/investmentstrategies.

Related Topics: Investment Strategies