Where to invest in the next 10 years, 20 years and 30 years?
In our view, the answer unequivocally is emerging markets.
The following article was originally published in “What I Learned This Week” on March 28, 2019. To learn more about 13D’s investment research, please visit our website.
In 1988, we read that it took 70 years to build a landline system in the UK, 50 years in the U.S., 30 years in Japan and 20 years in South Korea — but it would take only 1.5 years to put in a mobile system. This is what we call the late-mover advantage. That very simple data point turned us very bullish on emerging markets. We started by investing in global telecom companies, such as Telmex and then moved on to Hong Kong Telecom, which led us to see, well before others, the rise of China (1992) and the explosion of the internet (1994). When we recently read how solar power is taking the emerging world by storm, we had a similar “aha” moment. (See “Collapsing prices are making solar and battery storage incredibly competitive”, WILTW February 7, 2019.)
This brings us to the LONG-TERM investment case for emerging markets. Emerging markets are perceived by many investors as riskier than developed markets due to their geopolitical stereotypes. But many of those stereotypes no longer apply. It is important to contrast the backlash against capitalism in the U.S. with the improving governance and market-oriented attitudes in emerging markets. Also, diversifying by country can greatly reduce sovereign and geopolitical risk. And the potential mean reversion between financial assets and commodities in the next few years should provide additional support.
Currency risk is an issue, but that cuts both ways. Eight years after the U.S. dollar’s post-GFC low, any sustained loss of confidence in U.S. growth and fiscal prospects could trigger a sustained outflow from the dollar. The greater risk is a continued slowdown in China’s growth rate and a deterioration in U.S.-China relations.
Consider the following:
- Solar power is enabling developing countries to leapfrog traditional grid infrastructure. Over one billion people worldwide live without electricity — half in sub-Saharan Africa alone. The World Bank estimates that if sub-Saharan Africa had continuous energy supplies, the region’s GDP growth would accelerate two percentage points per year. Solar power is already the same price or cheaper than new fossil fuel capacity in over 30 countries. In the sunniest regions of the world, solar is simply the cheapest unsubsidized power source. Ray Kurzweil calculates the world is only about six doublings away from solar energy accounting for 100% of power generation — a level potentially set to be reached by around 2030.
- Emerging markets contain the majority of the world’s millennials — a huge demographic dividend. Millennials now number 1.8 billion globally, about a quarter of the world’s population. And 90% of them live in emerging economies. Chinese millennials alone (351 million) outnumber the entire population of the U.S. But the important number to watch is the proportion of millennials relative to a country’s overall population. Standouts in this category include Bangladesh, Vietnam, and the Philippines. Consulting firm AT Kearney calls these countries the eight “Millennial Majors.”
We quote AT Kearney: “There is an inverse relationship between the relative size of a country’s Millennial population and its GDP per capita…The link between increased wealth and both decreased fertility and greater longevity has been well documented.”
But with unprecedented access to capital and technology, millennials in certain markets are on the cusp of tipping this balance. Compared to the U.S., where entrepreneurship rates for people under 30 have fallen by 65% since the 1980s, hitting a 24-year low, emerging markets are now hot-beds for millennial entrepreneurs. A 2014 Pew Research survey found that more than 95% of Vietnamese, 80% of Bangladeshis, and 73% of Filipinos supported free markets.
As Cale Tifford observed in the FT:
“Based on sheer numbers alone, the “millennial moment” is more a story of developing countries and global progress than the advertising stereotypes of affluent urban youth prevalent in western media and marketing.”
3. Emerging markets have a late-mover advantage in adoption of Fintech. In 2016, China’s mobile payments market hit $5.5 trillion, roughly 50 times the size of America’s $112 billion market, according to iResearch. By 2017, almost half the world’s digital payments were made in China, with values topping the worldwide totals of both Visa and Mastercard. Since then, the pace of mobile payments has accelerated further. According to research by Analyses, China’s two dominant players, Alibaba and Tencent, handled more payments in one month in 2018 than PayPal’s $451 billion for the entirety of 2017.
We quote Yuan Yang, reporting for the Financial Times:
“The mobile payments revolution in China has happened with breathtaking speed and scale. In only five years it has transformed daily life in Chinese cities and also laid the foundations for the country’s mammoth financial tech industry.
The transformation has been spearheaded by millennials, who were the early adopters of mobile payments, but it has spread across generations.”
Nearly 90% of people under 30 live within the emerging economies. According to PWC, this is also the age segment that accounts for 75% of online transactions. Feidee, a mobile personal-finance platform in China, says that 93% of its 3 million daily active users were born after the 1980s, and 42% of these were born after the 1990s, according to reporting by The Financial Times.
All eyes are on Southeast Asia for Fintech growth in 2019. A report from Deloitte published on 31 December 2018 estimated that Fintech investments in Southeast Asian countries in 2018 exceeded the $5.7 billion invested in 2017 by up to 30%. The region’s Fintech market is expected to reach $72 billion by 2020.
Ray Chan, vice president of Ant Financial, Alibaba’s payments arm, has said: “When we consider new products, we create them for this era, one in which young people have become the main driving force of our society.”
4. Emerging markets dwarf the rest of the world in terms of population. Here from The Future is Asian: Commerce, Conflict and Culture in the 21st Century by Parag Khanna:
“Asia…accounts for 60 percent of the world’s population. It has ten times as many people as Europe and twelve times as many people as North America. As the world population climbs toward a plateau of around 10 billion people, Asia will forever be home to more people than the rest of the world combined…
Asia contains half of the world’s largest countries by land area, including Russia, China, Australia, India, and Kazakhstan. Asia also has most of the world’s twenty most populous countries, including China, India, Indonesia, Pakistan, Bangladesh, Japan, the Philippines, and Vietnam…”
And here from Has the West Lost It? by Kishore Mahbubani:
“The statistics for the growth of middle classes globally are staggering. From a base of 1.8 billion in 2009, the number will hit 3.2 billion by 2020. By 2030, the number will hit 4.9 billion, which means that more than half the world’s population will enjoy middle-class living standards by then…
What Indonesia and Malaysia have accomplished today, Algeria and Tunisia can accomplish tomorrow…Behind North Africa, an even bigger demographic explosion is coming. Africa’s population will become as large as Asia’s by 2100.Then there will be 4.5 billion people in Africa. How will an ageing population of 450 million Europeans deal with this demographic explosion? Europe must become cunning and focus on its own existential challenge.”
5. Emerging markets will account for a progressively larger share of not only economic growth but the global economy.
Here from The Future is Asian: Commerce, Conflict and Culture in the 21st Century by Parag Khanna:
“The Asian economic zone — from the Arabian Peninsula and Turkey in the west to Japan and New Zealand in the east, and from Russia in the north to Australia in the south — now represents 50 percent of the global GDP and two-thirds of global economic growth. Of the estimated $30 trillion in middle-class consumption growth estimated between 2015 and 2030, only $1 trillion is expected to come from today’s Western economies. Most of the rest will come from Asia. Asia produces and exports, as well as imports and consumes, more goods than any other region, and Asians trade and invest more with one another than they do with Europe or North America. Asia has several of the world’s largest economies, most of the world’s foreign exchange reserves, many of the largest banks and industrial and technology companies, and most of the world’s biggest armies.””
And here from Has the West Lost It? by Kishore Mahbubani:
“From AD 1 to 1820, the two largest economies were always those of China and India. Only after that period did Europe take off, followed by America. Viewed against the backdrop of the past 1,800 years, the recent period of Western relative over-performance against other civilizations is a major historical aberration…
In 1976, the West launched the G7 to bring together the world’s most powerful economies. Their share of the global GDP was 45.3 per cent in 1995. By contrast, the share of the E7, the seven largest emerging economies, then was half that at 22.6 percent. However, by 2015 their respective shares were 31.5 per cent (G7) and 36.3 per cent (E7). PricewaterhouseCoopers has forecast that by 2050, the G7 share will slide to 20 per cent and that of the E7 will have risen to almost 50 per cent in purchasing power parity (PPP) terms…
By the rule of 72, if a country grows at 5 per cent a year (and many developing countries are achieving this rate of growth), a country’s per capita income doubles every fourteen years. Hence, in the next thirty years, if most of the states grow at this rate (and the three most populous states — China, India and Indonesia — are at least likely to do so), the standard of living of a vast majority of humanity will quadruple in the next thirty years. This statistic, more than anything else, should occupy the thoughts and approaches of governments and rulers around the world.”
6. Progressively more emerging countries are enjoying functional instead of dysfunctional governance. Kishore Mahbubani makes this case in Has the West Lost It? Functional government is defined here as good enough to improve the lives of its people and raise living standards.
“Many Western populations are losing their trust in governance, while Asian levels of trust are increasing…This rising belief in rational governance is happening not just in Asia…By contrast, many strongman rulers in Africa today are focused on rational governance of their societies…
A region-by-region analysis would show that every region in the world enjoys more functional than dysfunctional governments. Southeast Asia was a hotbed of conflict and strife from 1945 to 1985. Now…all the ASEAN governments are functional and thrusting Southeast Asia forward to become the fourth-largest economic area in the world by 2050.
No other region can show such a sharp contrast between its dysfunctional past and its functional future but Southeast Asia is not an exception. South Asia, another strife-ridden area, now probably has only one dysfunctional government, Nepal…Even Pakistan and Bangladesh are progressing slowly and steadily.”
7. Emerging markets have the potential to leapfrog bricks and mortar with online market places. Generating employment is an urgent priority across much of the developing world, most notably sub-Saharan Africa. By 2035, more sub-Saharan Africans will be reaching working age (15 to 64) each year than in the rest of the world combined. Each year for the next ten years, 11 million young people in sub-Saharan Africa will join the job market. Because the region currently lacks an efficient distribution infrastructure, online marketplaces represent an enormous opportunity to boost employment and incomes.
As a recent report by the Boston Consulting Group details, these digital businesses create demand for personnel in platform development, as well as for merchants, marketers, craftspeople, drivers, logistics clerks, and hospitality staff. Some also offer skills-development programs and help small enterprises raise capital to expand their businesses.
Online marketplaces also boost demand for goods and services in areas currently beyond the reach of conventional retail networks and bring new people — such as women and youth who may be currently excluded from labor markets — into the workforce. As Lisa Livers, a BCG partner and co-author of the report, How Online Marketplaces Can Power Employment in Africa observes: “While online marketplaces are often seen as disruptive forces in advanced economies, in Africa’s less-structured economies they can be tremendous catalysts of economic development.”
In 2018, there were only 15 stores per one million inhabitants in Africa compared with 568 per million in Europe and 930 in the U.S. This extremely low penetration suggests that there’s minimal risk that e-commerce will displace existing retailers and that much of the population is underserved. Nor are online marketplaces likely to disrupt labor-market norms by blurring the lines between employees and freelancers. Unlike in developed economies, the vast majority of African workers are in the largely undocumented and unregulated informal sector. In Nigeria, for example, 71% of workers are self-employed and another 9% contribute labor as family members.
8. Given all of the above, valuations are compelling. And yet the Emerging Markets Free Index is selling at the same level as 12 years ago, as can be seen in the chart below. It appears to have formed a huge base that may be in the process of breaking out. Students of market history know that the bigger and longer the base, the bigger the ultimate bull market.
The MSCI Emerging Markets Index (MXEF) has gained 11.7% off its October 29, 2018 low, nearly double the 6.2% rise in the S&P 500 index. The chart below shows that the EV/EBITDA valuation gap between the MXEF and the S&P 500 index is the highest in nearly a decade, based on current-year consensus estimates.
The MXEF also trades at only 7.7 times consensus FY2020 EV/EBITDA, a 26% discount to the S&P 500 index comparable multiple of 10.5 times. Yet, the underlying components of the MXEF have a higher expected long-term growth rate (12.6% vs. 9.5%). The MXEF is also only marginally above its absolute September 2015 historical low of 7.1 times, and below its median of 8.6 times.
Mark Mobius of Mobius Capital Partners noted this month in a Bloomberg interview that when he started investing in emerging markets in 1987, they accounted for only 5% of global market cap. Today, they represent about 40%. In Mobius’ early days, he could only invest in six markets. Today, it’s about 70, which makes diversification so much easier. “If you like technical analysis, many of the markets had a double bottom.”
This article was originally published in “What I Learned This Week” on March 28, 2019. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.
