I’m still positive on EM even in the face of escalating tariff wars and a slowing global growth backdrop. It is not a straight on embrace of EM as a whole, but I do believe that there are opportunities within.
So first reason is that EM is less efficient. And these market inefficiencies are likely being compounded by tariff uncertainties and a massive economic shift that’s occurring in China.
The second reason while China’s rate of growth is slowing, the level of growth remains attractive and there are definite growth pockets within China coming from strong investment spending in areas like biotech, fintech, and other parts of technology.
Lastly that middle class growth story. Because it is a robust story and because you can’t find it outside of the EM.
So when you combine these three things you get a picture that is very different from the developed world, suggesting that by adding EM exposure, it should provide growth and diversification benefits to domestic investors.
OK so let’s dig in a little bit further. The biggest story, and one that I don’t think is talked about enough is China and the economic transition that they are going through. China has clearly been the driver behind the EM for the last 20 years. In the year 2000 it represented less than a percent of the MSCI EM Index – now it is 28%, (and that excludes Hong Kong). China reflects a success story basically at a scale that we’ve never seen before in terms of the history of the world in terms of how quickly they became a very urban manufacturing based economy. This led to tremendous growth in per-capita income. But that is no longer the story of China today. China has been transitioning really for the last five years from a manufacturing and export driven growth model to an inwardly facing economy that is more services and consumer based. And this shift was just really a natural outgrowth of what happens and occurs over an industrialization cycle. What China went through we saw the U.S. go through in the 1950s and 1960s and Japan in the 1970s and 1980s. China’s success translated into higher wages – and these higher wages force a shift to higher margin businesses to support the wages and it forces a shift of loss of low wage manufacturing. Again this same thing happened in the U.S. and Japan. Even before these tariffs came into place we’ve been seeing low cost labor intensive manufacturing moving out of China and into other EM countries, of course the tariffs now are accelerating this process.
So what does this mean? Well I want to take two paths from this. First path relates to most EM indexes.The fact that China is going through this massive transition means that the indexes are also going through that same transition. For example from the year 2012 to 2018 the MSCI EM index was basically flat on a price basis. But if you looked inside the index you would see a lot of shifting, technology, consumer based industries and sectors like these doing extremely well, but energy, materials, and banks – all of these areas that benefited from China’s infrastructure build out – those did not do well.
The other path I want to walk down relates to the waterfall effect that China’s creating for other EMs. You, for example, move a cell phone assembly facility to say India or Vietnam – or wherever, and then, with it comes all of these other supporting mfgs of parts surrounding that assembly facility you end up creating 10s of thousands of jobs basically that put people onto that middle class escalator.
Brookings estimates that there are 160 million people moving into the middle class every year. And with that comes discretionary income and spending. So while there are still plenty of investment opportunities inside China, I believe really the greater gains are going to come outside of China. And it’s going to be spread out. No one country can be the landing spot for all of that production. And these tariffs on China is kind of a wakeup call for producers to spread their bets.
Now I don’t want to come across as Pollyannish. The risks to investing, there are risks to investing in EMs, and those risks are being compounded by this tariff war. But I think that EM space is inefficient and in transition which means there’s opportunity. And there is vibrancy and growth to be had in EM, not found in developed markets which is really what keeps me interested as an investor.
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