What Makes an Emerging Market?

Emerging Markets used to be a bit easier to categorise. Twenty years ago, this was a bit more black or white and they really were the final frontier. The exotic, the distant and the remote.

Twenty years is not a long time in history. Göran Persson was prime minister in Sweden. Saving Private Ryan hit our cinemas. But it’s a long time in terms of business. Google was founded 20 years ago. It was still early days for Amazon. The fax was still commonplace. And the Chinese economy was around a 1/13th of what it is today1.

Fast forward to 2018 and the Chinese stock market is the second largest in the world1. 61% of global mobile payments are made in China2. Korean company Samsung is the 14th largest company in the world3. The opportunities offered by today’s emerging markets are modern stories of technology and the growing middle classes. Investors are looking for a sweet spot where the political and social growing pains have largely ended and the economic growth is at the beginning of its journey.

So how come some enormous giants are ‘emerging’!?

Counter-intuitively, some of the world’s largest stock markets are still classified as emerging markets, so it’s not necessarily a sign of being smaller and less potent. In the same way that some gorgeous hotels only have a 4-star rating because they only have one restaurant, some markets are classified as emerging for the following reasons.

1) Income per individual

The World Bank defines emerging countries as those with either low or lower middle income per person of less than about 4,000 US-Dollar.

Rapid growth is a common denominator of emerging and frontier markets. Although our vision of Argentina may involve tango halls and polo, between 2002 and 2017 Argentina’s average income per person grew on average by 5.0% per year. In the developed world, annual average growth rates were 3.1% over the same period. China and India are further examples of emerging market per-capita income growth, with annualised growth rates of 11.0% and 8.2% respectively4.

Any traveller to India will have noticed the burgeoning coffee shops with affluent middle-class urbanites sporting the latest logos, providing a stark contrast to the average standard of living seen around them. Average incomes remain low in emerging markets but, as always, averages disguise the top echelons.

26% of BMW’s global sales last year came from China5, where they have a joint venture with a local firm which develops, manufactures and sells them. By comparison, just 15% came from the US and 13% from Germany. The purchasing power of the middle class is strong. More Guinness is sold in Nigeria today than in Ireland6. Go figure!?

2) potential for volatility

These markets can be volatile. They tend to be more vulnerable to natural disasters, external price shocks from more powerful nations and domestic policy instability. A recent example is the trade spat between China and the US which has sent ripples around the rest of the world. Mexico is another clear illustration of how specific smaller nations can be wounded by the actions of others. That said, everything is relative. Increasing economic strength in the emerging markets means volatility is generally lower than in the past – even the volatility of the Swedish market has exceeded the emerging markets over certain periods.

3) Immature capital markets

A further factor in being classified as ‘emerging’ is a nation’s capital markets being ‘immature’. A market might not have a solid track record of foreign direct investments. Information may be harder to get. Some investments can be less easy to buy or sell. They may have capital controls. Corporate governance can be a little less ‘robust’. These are all risks but also make the markets less perfect. They add a bit of friction. Which adds potential return and competitor advantage for those on the ground, who do the leg-work to understand where companies are ‘sound’ and where it is better to walk-away.

4) Growth and risk

As some of the emerging markets flex their muscles and grow, they can offer impressive returns. Over the three years to the end of November 2018, one of the highest returning stock markets was Thailand which grew by 80.5% over the year7. A balanced global share portfolio feels incomplete without exposure to some emerging markets.

However, investors should be under no illusions and expect a bumpy ride. These markets can suffer from changing fundamentals or simply a fall from grace in global investor sentiment. Back in 2008, the year of the global financial crisis, the emerging markets sector recorded a six-month slide of almost 45%. Only to rise by nearly 80 % in the following year8.

As always it is extremely hard to pick winners in any market. Which emerging markets will rally forth and deliver strong growth, growing income per capita and improved capital controls, making the jump over into the developed markets club?

And which ones will languish by comparison?

If you don’t know the answer, buying a mixed basket of shares from a collection of countries is one way to spread your bets around.

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Important Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

All investments involve risks, including possible loss of principal.