The Rise of Emerging Markets

With the Chinese economy on the verge of overtaking America's, the importance of emerging markets, and the changing world order their emergence will create, comes more sharply into focus. As emerging market countries grow their GDP they present investors with opportunities to take advantage of that growth.  

But what exactly defines an emerging market? The term was first used by economists in the 1980's to describe developing economies. A country that's developing has characteristics that include movement towards a free market model, an increasing population of young people, an increasingly sophisticated infrastructure, more political stability (democracy as opposed to dictatorship), and a healthy level of foreign investment.

The four major emerging countries are Brazil, Russia, India and China - known in financial slang as the BRICs. The acronym was first used by Goldman Sachs in a 2003 report. Their belief at the time was that by 2050 these four countries would become wealthier than the current dominant economic powers. The BRICs are followed by the 'Next Eleven', namely Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, South Korea, Turkey and Vietnam.

It's worth reflecting for a moment on where we are now in terms of economic supremacy. Western economic dominance came about as a result of the Industrial Revolution, when the means to accelerate production raised output and helped propel  America to where it is today. Before the Industrial Revolution, population tended to be the determining factor in economic performance. What we're seeing now, amply demonstrated by China, is an exercise in industrial catch up. Combine this with an increasingly affluent population of 1.3 billion, which pushes up GDP, and you have the makings of a new economic superpower.

The interesting thing from a potential investor's point of view is that emerging markets are predicted to grow up to 3 times faster than America, according to the International Monetary Fund. Which offers the prospect of good returns. So what are some good solid reasons for including emerging markets in your portfolio?

Diversification: - emerging market countries don't mirror the performance of developed countries, which means they aren't subject to the same downturns. They will have downturns of their own periodically though, so they'll need monitoring.

Predicted growth prospects: - it's estimated that about 70% of global economic growth will come from emerging markets in the near future. India and China are predicted to supply 40% of that growth.

Surplus cash: - most emerging markets have a much better current account surplus than developing economies overall, with China predicted to have a surplus of $450 billion by 2016, as opposed to America's deficit of $643 billion.

Young people: - The workforces of Brazil and India have a high ratio of young people to those retired, which means there'll be plenty of young people supporting the state benefits of their elders. America and the UK by contrast have aging populations, which puts a strain on the welfare system.

Long term performance: - according to Morgan Stanley, who have a number of emerging market indexes, emerging markets have outperformed the developed markets for the last 15 years, a trend that should only continue.

Higher spend: - Consumers in the emerging markets are increasing their disposable incomes and therefore spending more money. The middle class is getting richer. Chinese consumers are prime spenders on luxury goods.

Technology sector: - Social networking is extremely popular in China, with sites like Weibo boasting 130 million active users. There's also Alibaba, which is flourishing and planning an IPO soon. It's the world's largest online marketplace. Russia has search engine Yandex, which now trades on the New York Stock Exchange. These are all money makers.

There are some compelling reasons to feel confident about the continued growth prospects in BRICs and other emerging market countries. Of course this speed of growth brings its own risks, and the amount of exposure to emerging markets in your portfolio should reflect this. Advisers recommend between 5% to 10%.

So, what is the state of, and immediate prospects for the BRICs in May 2014?

Brazil: - will be hosting the world cup this year and the Olympics in 2016, which means it's very busy building the infrastructure to support these. Unemployment rates are low as a resut. However, the forecast for this year sees Brazil's economy slowing, and inflation rising.  Growth is predicted to rise only 2.3%. There have been street protests over the use of public money recently, and President Dilma Roussef is not enjoying a lot of popularity. With some work to do, it seems Brazil won't be contributing greatly to world economic growth this year.

Russia: - the Ukraine crisis and the subsequent sanctions are hurting the Russian economy. The stockmarket and the Rouble have both fallen, and investors have taken around $60 billion out of the country in the last 3 months. In its favour it has plenty of income from gas and oil, and is running a current account surplus. But growth has slowed in the last 18 months, and Russia needs foreign investment, which it isn't getting. If sanctions start to bite things can only get worse. Its poor performance has led some experts to question whether it should be dropped from the BRICs.

India: - the rate of growth in India was down to just under 5% last quarter, down from the high of 9.3% in 2010. The prospects for renewed growth are positive, but a lot will depend on the results of the current election. If Narendra Modi emerges as the victor he is expected to make growth a priority. Economists are expressing optimism for the longer term.

China: - Growth is forecast to continue at about 7.5% this year. This represents a slowdown in recent years, but the government is reportedly happy to go at a slower pace while it introduces reforms like the abolition of the one child policy, and providing better healthcare and affordable housing. The Boston Consulting Group (a leading consultancy) is very bullish on China, and predicts steady growth going forward.

A bit of a mixed report then. Brazil and Russia not looking so healthy, but India and China with cause to be optimistic. It seems that some research is in order before taking the plunge into an emerging markets product. The road to those potentially higher returns could have some volatile ups and downs, but it's a market sector that can't be ignored.

Darren Winters