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Emerging Market Consumers: High Hopes and Ready to Spend

10 October 2014 in Trading Ideas

For decades, if not centuries, the focus of investors, as well as global capital, didn’t stray far from the manufacturing advances and consumer power of the developed world.

Even in the past 30 years, there didn’t seem much point to noticing anything outside of where most goods were shipped, sold and consumed: North America, Western Europe or Japan.

But those days may be showing signs of drawing to a close, and our newest motif represents an investment opportunity keyed to one of the fastest-growing segments of the global population – middle-class consumers in emerging markets.

The Emerging Markets Consumer motif is a portfolio of 25 stocks of companies that generate a majority of their revenue from consumer spending in emerging-market countries such as India, China, Brazil, South Africa and others.

Those countries are part of a long-term global tectonic shift that has doubled the ranks of the consuming class to 2.4 billion people as a result of the integration of peripheral nations into the global economy, the relaxation and removal of trade barriers, and the spread of market-oriented market economics.1

What’s more, McKinsey Global Institute projects that by 2025 the global consumer population will nearly double again to 4.2 billion people – more than half the people expected to be living on Earth at that time.

Driving most of that overall growth will be emerging markets, where McKinsey expects annual consumption will rise to $30 trillion in 2025, up from $12 trillion in 2010.

“As a result,” McKinsey says, “emerging-market consumers will become the dominant force in the global economy.”

How quickly has this happened? Consider the fast lane taken by automobile sales in China. A recent Ernst & Young report noted that as recently as 2001, the Chinese auto market was miniscule, with annual sales of fewer than a million vehicles.2

As per capita incomes increased, reaching $6,000 in 2008, the market began to rapidly expand. In 2004, for example, General Motors sold 1 car in China for every 10 it sold in the US; five years later, sales to each country were essentially even, with overall automobile sales in China exceeding 10 million vehicles.

Now, China has overtaken the US as the world’s largest market for auto sales.

Looming underneath this overall shift in global economics is a generational one — an emerging-market population in their 20s and early 30s who are confident their incomes will rise, have high aspirations, and are willing to spend to realize them.

These are the consumers that came of age in the digital era, and more than half of all global Internet users are already in emerging markets. As early as 2010, for instance, the penetration of social networks in Brazil was the second-highest in the world. Meanwhile, a recent McKinsey survey of urban African consumers in 15 cities in 10 different countries found that almost 60% owned web-enabled phones or smartphones.

As McKinsey pointed out, with e-commerce and mobile-payment systems spreading to even the most remote hamlets, emerging consumers are shaping – not merely catching up with — the digital revolution and circumventing developed-market norms, creating new corporate heavyweights like Baidu, M-Pesa, and Tencent.

Armed with the idea that creating an investment portfolio leveraged to the spending potential of emerging-market consumers could be a worthwhile pursuit, we began our process of motif construction.

For starters, we identified US-listed domestic and foreign companies that derive a majority of their revenue from emerging-market countries like India, China, Brazil, South Africa and Mexico.

Within that subset, we screened for companies in sectors that stand to primarily benefit from increased consumer spending due to a rising middle class. Remaining companies were segmented by their primary industry: e-commerce, food and beverage, retail, travel, automobiles and consumer goods.

Next, we focused on weighting the companies’ stocks within the context of their pure-play representation of the motif idea and their market caps. That involves first determining each company’s percentage of revenue that comes from emerging-market consumer spending. After that, a “purity factor” is applied to give greater relative weight to pure-plays and less weight to companies that generate a higher percentage of revenue outside of emerging markets.

Finally, stocks are weighted by their market caps, with adjustments for their emerging-market consumer exposure.

The Emerging Markets Consumer motif could be worth considering as a diversified alternative investment strategy to other consumer-oriented emerging-market stocks. But it stands to reason that there are risks to keep in mind that can impact the companies generating revenue from these emerging countries that can have an impact on your investment, including political and economic risks within countries trying to put their substantial footprint on the global industrial map. And while outperforming growth in these markets is most certainly not guaranteed, McKinsey noted that for those willing to tolerate the volatility that comes with being a early-mover to an emerging market, the US market leader among 17 major product categories in 1925 remained the No. 1 or No. 2 player – through a Great Depression and numerous recessions – for the rest of the century.

1McKinsey Quarterly, “Winning the $30 trillion decathlon: Going for gold in emerging markets,” August 2012, http://www.mckinsey.com/insights/strategy/winning_the_30_trillion_decathlon_going_for_gold_in_emerging_markets, (accessed Oct. 8, 2014).

2Ernst & Young, “Hitting the sweet spot: The growth of the middle class in emerging markets, http://www.ey.com/Publication/vwLUAssets/Hitting_the_sweet_spot/$File/Hitting_the_sweet_spot.pdf, (accessed Oct. 8, 2014).

Investments in foreign markets involve unique risks, including political and economic risks and the risk of currency fluctuations, which may be magnified in emerging markets, and should be considered prior to making an investment decision.