Baton passing to the emerging markets consumer

October 19, 2012

Is there a change of sector leadership underway within emerging markets?

For years, commodities and energy delivered world-beating returns to emerging market investors. Yet in recent years there are signs of a shift, says Todd Henry, equity portfolio specialist at T.Rowe Price.

With the China tailwind no longer as strong as before demand for oil and metals will not be as robust as in the past decade, Henry says. But in China as well as elsewhere, disposable incomes have risen as a result of the fast economic growth these countries experienced in the past decade.

Check out the following two graphics from T.Rowe Price.

The first figure shows that in the ten years to December 2007, just before the global financial crisis erupted, emerging equities returned 300 percent in dollar terms. The two sectors that won the returns race in this period were energy and commodities, with dollar-based returns of around 650 percent. This is not surprising, given the enormous surge in Chinese demand for all manner of commodities, from oil to steel, as it fired up its exporters’ factories and embarked on a frenzy of infrastructure improvements.

The chart shows that consumer discretionary shares (comprising of auto or luxury goods makers)  didn’t actually do too badly either,  returning more than 300 percent. But they sat 5th in the rankings, beaten also by financials and healthcare in terms of returns. Shares in consumer staples (essential goods) came in sixth.

But take a look at the second chart showing sector returns between January 2008 and June  2012.  What a turnaround. Now it is indeed the EM consumer who started to deliver,  with consumer staples returning around 70 percent in this period while discretionaries provided returns of around 40 percent.

It is worth pointing out here that consumer staples are essentially viewed as defensive stocks so do tend to perform well during a downturn. Yet the contrast with energy and materials’ performance is startling.

 

As economic growth in China and elsewhere slowed, these shares slipped to the bottom of the sector league table and an investor buying into these sectors would have made losses of 30-40 percent, T.Rowe Price calculates. Along with industrials, financials and telecoms they dragged the broader MSCI emerging markets index into the red.

Henry is betting that this trend will continue in the next ten years and has the EM consumer as his biggest overweight.

Industrialisation generates wealth, leading to consumerism…emerging markets already account for a larger share of global consumption than the United States. If you get 2 percent growth in the United States that will allow enough wealth to be generated domestically and regionally in emerging markets.

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