Riding a New Wave

Low growth is the “new normal”—but opportunity can still be found in emerging markets.

For the last several years, global markets have experienced a “new normal” of low economic growth and persistently low inflation. The tepid economic recovery from the global financial crisis of 2008-2009 is one factor driving the new normal. Low long-term bond yields and a flat yield curve bears evidence that the markets believe in the new normal as the base case scenario. Demographics lend further support to the case for tepid long-term growth. Global working-age population growth for the period 1980-2008 was 1.75 percent annually, but the rate is trending downward to an expected 0.71 percent annually over the next 50 years, according to figures from the World Bank. All else being equal, this translates to a roughly 1 percent loss in potential gross domestic product (GDP) growth. If this outlook proves correct, investors will continue to seek out investment themes that are not overly dependent on global economic growth. Our UBS Emerging Markets Equities investment team analyzed a spectrum of emerging market (EM) and developed market (DM) countries to conclude that EM countries offer several strong equity investment opportunities. The team further identified the most investable EM countries from a macro perspective, and the most promising investment themes and business sectors over the next five years. Several EM countries are poised to outperform on economic growth, but GDP growth alone often does not translate into improved equity market returns. Corporate performance and secular investment themes that are attractive in a low global-growth environment must also be present. The investment team has identified key EM growth themes for the next five years, which include: Consumer spending, healthcare, real estate, financials and information technology. Countries that possess inherent growth drivers will likely have an edge as profitable investments. To help them identify these countries, they drew on academic research into the drivers of economic growth, applied to the current environment.1,2,3 Using these and other sources to develop composite country rankings, they ranked 57 developed- and emerging-market countries across six of the key factors identified by the research: Working-age population growth during 2015-2020, average education (years), ease of doing business, per capita GDP in 2014 and purchasing power parity (PPP) in 2011, investment as a percentage of GDP and, finally, government consumption expressed as a percentage of GDP. The findings show that EM countries will likely produce 4.2 percent working-age population growth in the next five years, while DM countries may shrink by 0.2 percent. EM countries also have an advantage in catch-up potential, with lower per-capita GDP to begin with, greater investment as a percentage of GDP, and lower government consumption. The differences between individual EM countries however, are as great as the differences between EM and DM, hence, while investing in EM as a whole helps address the question of where to invest in the new normal, choosing the most promising countries can yield better returns. Among the structural drivers for growth in promising EM countries are: Rising income levels that are lifting over 400 million households from middle class to higher middle class; young, urban and tech-savvy consumers; and decreasing dependency ratios (ratio of non-working to working population) in many markets. These factors support not only rising consumption, but are also changing consumption patterns. Figure 1 shows where the team sees investment potential based on valuations, quality, liquidity and growth characteristics within various consumer segments in EM countries. Rapid changes in consumption patterns occur when consumers move from lower annual income (between approximately USD 1,000 to 5,000) to middle income (above USD 5,000). For example, consumption and income data across various markets show that 1) staples (basic items like food and clothing) typically tend to follow a plateau consumption curve; while 2) discretionary items (leisure and entertainment, health, education) typically follow a continuous growth pattern or have multiple inflection points. DM consumption patterns offer us a roadmap to understanding how EM country spending patterns may change as income rises. As average annual income rises above USD 5,000, for example, consumers begin to buy higher quality food and tend to trade up from informal food stalls to formal quick-serve restaurants when they eat out. As the team has seen in several countries, as incomes reach key threshholds, EM consumers are willing to upgrade and accept price increases in categories that improve their quality of life. This summary is an excerpt from a September 2016 report, researched and written by the UBS Emerging Markets Equities investment team. The full, 55-page report includes an in-depth analysis of individual EM countries and identifies the key attributes that indicate growth potential. It also examines several industries across EM, including real estate, information technology, healthcare services and financial services. To read more on this paper, click here or email us at assetmanagement-americas@ubs.com.
Endnotes 1 Robert J. Barro, “Economic Growth in a Cross Section of Countries,” The Quarterly Journal of Economics, Vol. 106, No. 2, May 1991, pp. 407-443. 2 Antonio Fatas and Ilian Mihov, “The 4 I’s of Economic Growth, INSEAD. 3 David E. Bloom, David Canning, Jaypee Sevilla, “Economic Growth and the Demographic Transition,” Working Paper 8685, National Bureau of Economic Research. Disclosure The views expressed in this commentary are as of September 2016 and are a general guide to the views and opinions of UBS Asset Management. The views and opinions expressed herein are considered “forward-looking statements” and have been compiled based on information from sources believed to be reliable and in good faith. All information, views and opinions are subject to change without notice and actual results may prove different from expectations. This commentary is at a macro or strategy level, not with reference to any registered investment company or other investment product, and should not be considered a recommendation to purchase or sell any securities, asset class or investment strategy. No part of this presentation may be reproduced or redistributed in any form, or referred to in any publication, without express written permission of UBS Asset Management. © UBS 2016. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.