The world has changed dramatically in the past 10 to 20 years. A wave of rapid economic growth in emerging markets has started a huge rebalancing of global wealth and power. Investors who rode the wave have profited handsomely. But there’s still a long way to go. Emerging markets remain the best hunting ground for stock market profits.
Long time readers will know that I like emerging market stocks. They have a multi-decade history of outperforming developed country stocks.
Below is a chart that illustrates the point. It compares the performance of three MSCI stock indices – Emerging Markets, USA and Europe – since 1987 (earliest data for all). All are measured in US dollars – so we’re comparing apples with apples – and include dividends – so we’re looking at total returns.
This outperformance has been driven by superior earnings growth (specifically earnings-per-share, or EPS). In fact if we strip out the unsustainable rises in P/E ratios in the US and Europe in recent years then the performance of emerging market stocks would have crushed the developed markets (see here for additional observations).
This is all tied in with rapid economic growth in emerging markets. For example, when measured in US dollars, China’s economy roughly quadrupled (!!!) in size over the past decade.
But it’s not just China. According to a recent report from PricewaterhouseCoopers (PwC) – “The World in 2050” – the rate of relative progress has been staggering.
The report compared the “G7” group of seven developed countries with the “E7” group of seven large emerging economies. The G7 consists of Canada, France, Germany, Italy, Japan, UK and USA. The E7 includes Brazil, China, India, Indonesia, Mexico, Russia and Turkey.
In 1995 the E7 economies were about half the size of the G7, using GDP at “purchasing power parity” (PPP) exchange rates. By 2015, just 20 years later, the two groups were about the same size.
(PPP adjusts for price differences for goods and services that exist between countries, and so is a measure of volumes of production and consumption.)
So what happens next? I think it will be more of the same outperformance for decades to come.
Emerging market growth will most likely be slower than in the past decade or two, as those economies mature. But productivity growth – a key driver of economic growth – will still far outstrip that of highly developed countries. It’s easier to copy and follow than it is to lead.
In other words, emerging market economies will continue to outperform. In turn, so will the stocks of companies from emerging markets (or that make most of their profits in those countries). The faster economic growth will continue to provide a boost to earnings growth when compared with developed countries.
PwC reckons the global economy will grow around 2.6% a year out to 2050 (that’s “real” growth, as in above inflation). Breaking it down further, it expects the E7 to grow at 3.5% a year whereas the G7 developed countries are expected to grow at just 1.6% a year on average.
(For comparison, according to the IMF, emerging markets grew on average 5.8% a year since 2000, and developed markets grew 1.8% a year. Both groups are expected to slow.)
The upshot is that by 2040 the E7 economies will be about double the size of the G7 (again at PPP), as shown in this chart:
In other words the pecking order of the world’s economic heavyweights will change substantially. As shown in this next image, Europe and the US (Trump or no Trump) will lose ground to countries like China and India.
Obviously the actual results could be substantially different. PwC itself stresses that these are estimated projections of potential, not predictions.
There’s always plenty of scope for politics to mess things up – let alone potential catastrophes such as global nuclear war or asteroid collisions with Earth (although, of course, we’ll have bigger worries than our investments at that point…). But, except in extreme circumstances, I see no reason to doubt the general direction of travel.
In any case, here’s how PwC thinks the ranking of the top 10 economies will change over time.
Clearly there are plenty of investment opportunities to be found in emerging markets. That’s especially true at moments when investors are looking elsewhere and stocks are cheap (see Russia, still…).
Emerging market stocks have outperformed developed market stocks in the past, despite being deeply out of favour in recent years (and US stocks being in a bubble today – see here). Given their superior economic growth that looks set to continue.
Of course it won’t all be plain sailing. But there are good reasons to believe this general trend will continue long into future.
I recommend you invest where the growth is. Focus your stock market allocation into the higher growth emerging markets – especially where you can find decent pricing.
Stay tuned OfWealthers,