The Single Most Important Global Trend

Published in Investing on 28 September 2011

And what investors can do about it.

It can be hard to focus on long-term trends when there is so much volatility and turbulence in the markets. But over a long-term investment horizon, it's the big trends that matter -- and one of the most significant is the relentless shift of the world's wealth to eastern economies such as China and India.

This shift will transform the investment landscape. The concept of the BRICs as emerging markets, and western nations as developed markets, will become outmoded. The future world might better be described in terms of growth nations and nations in relative decline.

Growth nations, such as the BRICs and their satellites, will enjoy healthy economic progress, rising standards of living, and increasing geo-political power. The declining nations of North America and Western Europe will suffer from weak economic growth, inflation and stagnant living standards.

Just how dire things become in the west is in the hands of politicians. That said, we can't rule out crashes, bear markets, asset bubbles, recessions and other reversals in the east. But the relative shift in wealth is practically a certainty. It will influence asset allocation, how we assess companies and where we look for growth.

Evidence

There is no shortage of evidence for the shift in wealth:

  • Economic growth: The IMF forecasts China's economy to grow by more than 9% during the next two years, and India's by more than 7%, compared with anaemic forecasts of 1-2% for the west;
  • Indebtedness: Western countries are burdened with near insupportable debt levels and in many cases large trade deficits, with China being America's largest creditor;
  • The rise of the eastern middle classes: The OECD expects Asia's share of the world's middle classes to grow from 28% to 66% by 2030;
  • The millionaire count: The Wealth Report from Ledbury Research reckons the number of individuals worth more than $10m in Asia-Pacific  will this year outstrip those in Western Europe, and match North America by 2015;
  • The shift in the manufacturing base: Western companies have moved manufacturing to 'low cost' emerging markets, while domestic eastern companies have grown. Prabhat Sakya points out that Britain's largest manufacturer is the Indian conglomerate Tata;
  • The shift in financial services: International resource companies and luxury-goods manufacturers are increasingly looking to markets such as Hong Kong to float. It is inevitable that financial services and allied sectors will also shift towards the centres of wealth, particularly as education levels rise there;
  • The commodity markets: Global prices now fluctuate according to Chinese demand, or expectations of it, and;
  • The decline of the dollar: Even some American commentators have joined China in calling for an alternative global reserve currency.

What will this mean for UK investors? First and foremost, I think it will require a different mindset, and a good dose of humility. And it needs a change of language, which colours thought processes. It is scarcely credible to call the BRICs 'emerging' or 'developing'. Those terms were predicated on the belief that they would model their societies on the west.

Asset Allocation

A more concrete effect will be on asset allocation. It makes sense to weight a portfolio towards those regions that have a greater share of the global economy and higher growth. Investors usually have a home bias which, I suppose, has two legitimate foundations: you know more about your home market so can invest more wisely, and you don't have direct currency risk.

We shall have to get to grips with the former. But a spin-off benefit of being a nation in relative decline will be a weak currency, so reducing the risk of investing overseas.

Even if we don't explicitly choose to invest more of our wealth in these new growth economies, it will largely happen by default as UK companies seek growth by investing there themselves. This isn't just taking place in obvious sectors, but in industries such as recruitment.

Knowledge

If asset allocation shifts eastwards, then to maintain our investment analysis and standards, we are going to have to improve our knowledge of those markets. First, that means learning some geography. For example, I know two facts about Indonesia:

1. It is the world's fourth most populous country, and;
2. That's the only fact I know about Indonesia.

So how can I adequately judge an investment in a company operating there?

Secondly, it means understanding something of the culture. A little bit of research on the Indian cinema-going market convinced me that Eros International (LSE: EROS) had better growth prospects than Cineworld (LSE: CINE), but to paraphrase Donald Rumsfeld, I know there are many unknowns. And even the great and good can struggle in foreign markets, as Anthony Bolton has discovered with his Fidelity China Special Situations Fund (LSE: FCSS).

Brands

Much of the emerging-market earnings of London-listed companies has come from leading brand names. The new middle classes relish well-known brands from the likes of Unilever (LSE: ULVR) and Diageo (LSE: DGE), and covet luxury goods from names such as Burberry (LSE: BRBY).

But it seems inevitable that economic power will be followed by political and military power, and then by greater cultural self-confidence. There is no reason why western brands should retain their cachet indefinitely. In time, emerging consumer markets will be dominated by local growth companies. And it will be domestic investors, investing through local stock exchanges, who will own the majority of them.

This coincides with the impact of demographics on western stock markets. The baby boomers who have fuelled equity market growth will withdraw funds as they retire or, with a greater life expectancy than previous generations, keep them invested in safe, moderately-yielding income shares.

Low-growth cash cow western companies may become the mainstay investment for this group. But for any growth, you'll have to look east.

More from Tony Reading:

> Tony owns shares in Unilever, Diageo, Eros and Cineworld. The Motley Fool owns shares in Unilever.

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Comments

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AleisterCrowley 28 Sep 2011 , 11:16am

I'm rather glad I'll not be around to see it.

jaizan 28 Sep 2011 , 8:44pm

Stagnant Western living standards? Things are by no means guaranteed to be that good.

Our countries have been living beyond our means, are heavily indebted and we subsidize non-performers via a socialist security system. A significant proportion of the population are lazy, indolent and have shown no interest in education or work. They act as a brake on the wider economy.
Falling living standards are very much a possibility.

wellington101 29 Sep 2011 , 7:52am

It is without any doubt the money is moving to the East look out for TSCO.L Tesco's as they expand in the east.
I am looking to expand my portfolio towards the new middle classes. Always follow the money!

donovan5 29 Sep 2011 , 3:02pm

Will America just take the shift in power with good grace though?Or will we hear of more and more Eastern terrorist plots that require military intervention

NabilAdams 29 Sep 2011 , 10:26pm

I disagree with the basis of this article. Transfer of wealth implies a assumption of taking from the developed economies and adding for the emerging economies. This is not the case. The global economy doubled in size between 2000 to 2010, and is predicated to double many times in the decades ahead. What this means is that whilst most of this growth will be in the emerging economies, it will not be at the expense of the West as everyone will get a share of a bigger cake.

Using the authors thinking, when 100 years ago the USA overtook the UK as the world largest economy, the UK was in decline, not true, in the last 100 and most importantly last 40 years the UK has enjoyed its highest ever living standards and is richer than ever, irrespective it has dropped from 1st to 6th largest global economy.

The UK as well as the West will continue to enjoy economic success in the long-term because of better use of human capital and open transparent laws and enforcement. The reality is the emerging economies are a play on the developed economies. Brazil has been emerging for the last 40 years, Corruption (India) and revolution (China) will send them to the same pages of history as those who said the USSR would eclipse the USA, and those who predicted the Asian Tigers of Thailand, Malaysia would be developed nations by 2020. We have been here many times before, true long-term economic growth is from human capital, and human capital is best suited to the laws and culture of the West. No doubt the East will emerge and grow, but it will be to the benefit of the West, not at its expense.

pickepics 29 Sep 2011 , 10:32pm

The basic thrust of your article is correct, Tony. But it will require something more. We'll need to be aware of political as well as economic and industrial developments across a diverse range of geographical areas if we intend to hold investments rather than make very short term speculations. Either that or have a very high risk profile.

Even today's biggest mover and shaker, China, has high levels of civil unrest. All have problems of one sort or another. We need to understand where we are investing, i.e. will our ownership be honoured next week, as well as undertaking the usual Fool/Graham/Value research.

pickepics 29 Sep 2011 , 10:48pm

NabilAdams, with respect, you are reading things into the article which are not there. Where is the transfer of wealth implied, let alone stated? Whilst I agree with your overall thesis, i.e. we are all likely to benefit from the advancement of the rest of the world economically, the trend is now so well established that to argue against it has as little foundation as to argue continuing UK dominance in the immediate years preceding USA overtaking UK in the economic rankings.

You could, with value, argue that the movement of manufacturing capacity was a major mistake (count the costs, it was at the time, the management consultancy justificcation was warped) but you cannot argue realistically, as you implicitly attempt in your final paragraph, that the west and much less that the USA, will remain economically dominant for longer than a few more short years.

TRhere 30 Sep 2011 , 12:17pm

@NabilAdams,

I was talking about *relative* decline, and so I wouldn't disagree with your thesis that the whole world may get richer and richer.

But my argument is that with relative wealth - and hence power - shifting eastwards, we are going to have to be more realistic (i.e. humble) about the influence of the west. If, as you argue, human capital is the main driver of growth, then the East has more in quantity (with growing populations against declining, ageing populations, immigration apart, in the west). And with a greater share of the world's wealth they wil be able to educate their populations better. In time they will have better educated investment bankers/engineers/politicians/whatever. Whether they will think that they are better suited to the laws and culture of the west, or not, will be their decision, whether we like it or not.

The UK exported its values to the US in the 17-18th century, by boat, so had little difficulty with US's approach to business becoming dominant in the 20th century. We might have to accept that the world doesn't play by our rules in the future.

NabilAdams 30 Sep 2011 , 8:09pm

We are in agreement, that China, India and co. will develop faster and become richer in the years ahead and it stands to reason that in the long-term because of their population sizes, they will likely be top 4 in the world GDP list sometime soon, and Indonesia, Brazil and Turkey will be knocking around not far behind. My main point is that I feel this will not be at the expense of the West.

@Floorlord – regarding the movement of manufacturing capacity. Physical manufacturing is simply part a small part of the value chain, please do some research on the iPod (made in China) example to see where the wealth flow ends up (USA). ARM is another example. In my opinion for China to become “economically dominant” at the expense of USA it has to make and own intellectual property across the value chain. Making cheap shoes, and keepings its currency abnormally low will not make it dominant, but will make it rich until such a time the world allows it to manipulate the currency (hence world trade) markets.

@TRhere - Let me expand on my point of human capital. A few old men in grey suits in China (the Communist party leadership) will be unable to manage and grow the Chinese economy, as for it to grow and challenge USA and Co. requires dynamic human capital. It’s wealth thus far has been making cheap goods and manipulating its currency, China needs USA to buys its goods more than USA needs it to buy its debt.

We have a live example today in Singapore, a developed, educated and rich country which I have lived in. The Singapore government was a few years back scratching its head asking why is our population not dynamic, why are they a bunch of salary workers and not able to create anything of note, the reason is the government has for 60 years controlled every aspect of their lives which has turned the population into robots. For India and China to become dominant economies requires a population which is more than “cheap” (in the sense of cheap delivery of goods and services), as sometime soon someone cheaper will come along, its requires a dynamic creative and intellectual population which in China’s case stands against what the communist party is all about, so in the long-term you have 2 opposing forces.

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