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.
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.
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.
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).
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.