Global powerhouses to benefit from supplying emerging economies
As economic power shifts to emerging economies, Marriott recommends that investors look to global giants which will benefit from providing skills and products to those countries
There is little doubt there has been an ongoing shift in global economic power in recent years, and this appears to have accelerated since the development of the US sub-prime crisis. This 'globalisation' process has benefited those emerging economies that have relaxed controls on inward investment coupled to large and growing populations with a desire to embrace a western lifestyle. This, undoubtedly, poses significant challenges for western companies, but it also provides huge opportunities for those corporations with the skills and abilities to adapt to both the needs of these emerging economies and the aspirations of their populations.
In many ways, the latest economic power shift is merely the continuation of a longer evolutionary process. The rise of Japan in the post-war years perhaps marked the start of this eastern migration, whilst the emergence of the so-called 'tiger' economies in the 1980s and 1990s provided an almost natural extension of the trend. Over the same period, the 'BRIC' countries (Brazil; Russia; India and China), were seen as having great potential, albeit with higher risk. However, it was after the 1997 Asian financial crisis that the region emerged stronger, both in terms of fiscal and monetary controls and better corporate governance. Since that time, many of these markets have acquired an almost developed status, whilst the 'sleeping giants' of the BRIC world have risen to prominence, together with other emerging markets.
The rise of these massive emerging economies has not been without problems. Economic success has led to increased internal investment as economies enter a massive period of transition and the infrastructure for a more western lifestyle is put in place. This has produced a rapidly rising middle class which has demanded ever-more access to material goods. The resulting rapid industrialisation has led to a huge rise in demand for commodities which, in turn, has caused a spike in oil, as well as a broad range of both 'hard' and 'soft' commodities. With simultaneous financial turmoil in western economies, this has acted as a significant headwind to economic recovery in those markets.
Given the changing balance of economic power, it might be tempting to question the need to invest in First World economies. While a natural response, it ignores the crucial role that powerful global companies will have in the massive infrastructure developments of the emerging world. Technological expertise and innovation still remain in the West, which gives those companies with the ability to compete and adapt huge opportunities for expansion into hitherto minor (or closed) markets. In the case of the US, the weakening of the US Dollar against most Asian and emerging currencies has also provided its major international corporations with a competitive advantage in the drive for new business opportunities. In addition, the credit crunch, resulting from the US sub-prime problem, has driven western valuations to attractive levels relative to their emerging market counterparts, making the case for the former even more compelling.
Looking at the emerging markets, whilst returns over the past four years have been exceptional, the very forces that gave them this advantage now look to be turning against them. The growing demand for oil, commodities and food is leading to inflationary pressures in those economies which, until recently, seemed to be immune. Many emerging economy governments lack either the ability or the political will (or both) to control higher domestic and import prices, which are now starting to affect their economies and cause social unrest. With food representing a much larger proportion of CPI in the developing world (China 33%, India 57%), the impact should not be underestimated.
The West curbs inflation through engineering an economic slowdown which in turn creates insecurity and lowers confidence to bid up prices or wages. However, some Asian governments continue to believe in striving for economic growth given the prosperity it has brought. As a result, Asian inflation is now at a 9½ year high of 7.5% and monetary policy remains loose. Pakistan's inflation is now 17.2% and negative real interest rates can still be found in Thailand, the Philippines, Singapore and Hong Kong. However, India has taken a more aggressive stance towards inflation, which has led to a sharp slowdown and China, too, is changing its main priority from economic growth to curbing inflation. So care should be taken that the region may be about to enter a period of change as priorities are re-evaluated and markets come under pressure.
In summary, for the first time in a number of years emerging markets seem to be facing a period of potential underperformance. Of course, some economies are likely to buck this trend, such as the energy-rich Middle Eastern countries and Brazil, with its wealth of commodities. However as far as the asset class as whole is concerned, the smart money should look to switch into those global powerhouses of the West that can exploit the opportunities that will continue to arise.
