Innovation and growth: the rise and rise of emerging markets

Light trails from traffic in Jakarta, Indonesia

last updated 14 June 2021

The great constant of our globalised world is that connected markets are always adapting and evolving. There are some obvious transformations that are hard to avoid, with the rise of emerging markets dominating our attention. According to Statista, by 2025 the GDP for emerging markets is forecast to reach $49.59 trillion – up from $37 trillion in 2021, a 34% increase. It’s also, Statista says, eclipsing the $20.3 trillion the EU is predicted to reach by 2025.

Have emerging markets passed the Covid test?

That EM growth is in part reflected in another epochal, global transformation – countries throughout Asia in particular are urbanising at an astonishing speed. One small (or actually not so small) example demonstrates this shift to what are now called mega cities. According to Our World in Data and the UN, the city population of Beijing has grown from a couple of million residents in the early 1950s to just under 20 million by the end of 2020, with a forecast of 25 million residents by 2035. Delhi and Mumbai in India may even beat the Chinese capital to that 25 million mark sooner, perhaps as early as 2025. That’s around three times the current population of New York City (8.419 million) or London (8.982 million).

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

A report from consulting firm McKinsey declared that “by 2025, annual consumption in emerging markets will reach $30 trillion”, up from $12 trillion a little over a decade ago in 2010 (a sharp 150% rise), and account for nearly 50% of the world’s total. Even quasi-government agencies such as the IMF sometimes succumb to the numerical hype: the IMF recently observed that approximately 85% of the global population live in emerging and frontier markets where they represent approximately 6 billion shoppers. And they’re increasingly young as well with 90% of that population under 30.

And care to guess what many, if not most of those young consumers spend their time doing outside of work? Many of those activities are likely to be enabled by the internet and technology broadly, and smartphones specifically. Newzoo is a data platform based around gaming – its surveys reveal that in terms of smartphones China boasts 63% penetration with 911 million smartphone users, a number that’s more than double the population of the US. In participation rate terms Indonesia is not far behind at 58% (and 160 million users) and Brazil at 51% (and 109 million smartphone users). India may only have 31% penetration but that equates to 439 million smartphone users. These stats can sometimes make investors feel a bit dizzy but a simple formula jumps to mind. Start with billions of new consumers, add internet access and then layer in many more smartphones, all of which equals a huge consumer revolution.

This dramatic series of global transformations is echoed in a more subtle way in the world of emerging market investing. If you’d have asked most investors a decade ago what emerging markets meant to them in practical stock selection terms they might have mentioned booming banks, more building materials for those huge cities and bustling energy businesses. Now emerging market investing is increasingly about technology and consumer products. In fact, they’re much less dependent on making cheap goods to export to the US and have high intra-region trade driven by ASEAN (Association of Southeast Asian Nations), an economic union between 10 member states in Southeast Asia.

One way of understanding how investing in emerging market equities has changed is through the lens of one of the leading actively managed investment trusts in the UK: Templeton Emerging Markets Investment Trust (TEMIT), offers an ideal entry point for investors looking for opportunities and exposure to EMs. If we go back in time to the heady days of 2008 we see that Consumer stocks (discretionary and staples) were just 9.7% of the portfolio as opposed to 22% today. IT (and what is now communication services) stocks comprised 9.2% of the portfolio as opposed to 48.3% today. By contrast energy was just under a quarter of the portfolio (now just 2.3%) and miners 15.8%, now down to 4.3%.

Tech businesses dominate these lists for an obvious reason – as we have already noted the consumer technology markets in Asia in particular are already gigantic in scale. But they are also innovative as well. The reason why the likes of Alibaba and Tencent dominate the list of most EM portfolios is because they have pushed the frontier of digitisation, e-commerce and finance to the limits. In China cash is becoming obsolete and multiple home delivery firms compete to deliver to hundreds of millions of homes. Talk to many experts based in the UK, and they may privately admit that places such as China are far ahead in terms of new product adoption.

But investors also need to acknowledge that mixed in with admiration for all this growth and innovation is also a subtle note of cynicism, especially in recent months as the Chinese regulators have moved to restructure fintech firms such as Ant Group. The Alibaba affiliate is now a financial holding company overseen by China's state-controlled central bank. Chinese technology businesses in particular have sold off aggressively as Western societies begin to exit lockdown.

According to Asian analysts at French investment bank SocGen two key Chinese tech indices have declined by between 30 and 35% since their February high and might even be said to be approaching “acceptable” valuations – they are certainly back to their 2014 level, with one index (the CSI overseas internet sector) trading at around 32x forward earnings. Yet this against a broader global backdrop which is increasingly positive: revenues are growing again and more and more innovations are emerging out of Asian labs, plus at some stage India will begin to recover from its second Covid wave. Add in a weaker dollar (always good news for emerging markets) and booming demand from Western consumers for imports (from Asia) and the scene is set for a potentially transformational few years for key EM players.

MoneyWeek is written by a team of experienced and award-winning journalists, plus expert columnists. As well as daily digital news and features, MoneyWeek also publishes a weekly magazine, covering investing and personal finance. From share tips, pensions, gold to practical investment tips - we provide a round-up to help you make money and keep it.