Emerging Markets’ Growing Middle Class a Boon for U.S. Investors: Outlook 2012

EM is a good buy as U.S. and European economies struggle, say strategists and portfolio managers

Indonesians on Black Friday raised their fists to show 'priority' wristbands as they jammed a Jakarta shopping mall to buy the first BlackBerry Bold 9790s. (Photo: AP) Indonesians on Black Friday raised their fists to show 'priority' wristbands as they jammed a Jakarta shopping mall to buy the first BlackBerry Bold 9790s. (Photo: AP)

Heads up, investors: the world is getting flatter.

As Occupy Wall Street protestors in November were bemoaning the decline of the U.S. middle class, impatient Indonesians on the other side of the globe were raising their fists in mobbed shopping malls on Black Friday to show the “priority” wristbands that would let them be among the first to buy the new BlackBerry 9790.

“Emerging markets are a good buy” is now a favorite theme of investment strategists and portfolio managers as they present their outlooks for 2012.

Why? T. Rowe Price Fixed Income Director Michael Gitlin put it precisely during a media breakfast in New York: “It’s getting more and more difficult to determine what is emerging.”

Opportunity Abroad

Yield-hungry U.S. investors may very well find in 2012 that the best opportunities lie abroad. Emerging nations are selling the goods they manufacture to an ever-growing number of middle-class consumers at home, emerging market fundamentals are strong, and the economic woes suffered in the U.S. and Europe may be an EM drag—but not for long.

During the 2012 outlook season, investment strategists and other market watchers have repeatedly taken note of the growing middle classes in places like China, Southeast Asia, India and Brazil. These regions are rising to match the demand for goods that the developed world has seen for decades—at the same time that consumers in the U.S., U.K. and Europe are tightening their belts.

Emerging markets offer “intriguing growth prospects” over the longer term, said Scott Berg, portfolio manager of T. Rowe’s Global Large-Cap Stock Fund. “Ultimately there will be market recognition of the superior long-term fundamentals in the emerging world.”

Emerging economies are poised to benefit from better fiscal conditions, under-control inflation and strong GDP growth relative to developed markets, said T. Rowe’s Gitlin, who predicts that developed economies will continue to lag emerging ones. Pointing to International Monetary Fund forecasts, he said GDP growth in the next three years will be about 2% to 3% in the advanced G7 economies versus about 7% for the emerging and developing economies.

Newcomers Swell BRIC Ranks

Goldman Sachs Asset Management Chairman Jim O’Neill—the man who 10 years ago was credited with coining the term “BRIC,” in reference to the developing economies of Brazil, Russia, India and China—said at the time that the BRIC countries should become more central to global economic policymaking because their combined global GDP could rise to 14% from 8%. Today, that figure is closer to 20%.

Looking forward with the BRIC economies, O’Neill said in a Nov. 28 analyst note that they have grown to around $13 trillion and are

poised to overtake the size of both the United States and the European Union in coming years. And he now adds Indonesia, Korea, Mexico and Turkey to his list of growth markets.

“I spent Friday in one of the non-BRIC growing economies, visiting Istanbul to present my views of the world for a major client. I was literally in and out, but what a remarkably vibrant city Istanbul is these days,” O’Neill wrote. “I cannot understand why continental European countries are not more eager to embrace this country, especially as it would seem like an obvious credible model for some of the dramatically changing nations in Northern Africa and the Middle East.”

China Is Still a Buy

To be sure, it’s difficult to predict the timing on just when the markets will recognize the emerging world’s superior long-term fundamentals, said T. Rowe’s Berg. And as for the biggest of emerging markets, China, investment strategists agree that it is experiencing some troubles in terms of consumer inflation and a slowing manufacturing sector.

But those troubles will be short-lived, they say.

“In bullishness reminiscent of the technology bubble of the 1990s, analysts who work for investment banks based around the world rate nearly every Chinese stock they cover as a ‘buy,’” reported The Wall Street Journal on Nov. 28. Analysts have 19.2 “buy” recommendations on Chinese stocks for every one “sell” recommendation, The Journal reported, citing data compiled by research firm Forensic Asia Ltd.

Investors’ anxiety over an economic slowdown in China have seen that country’s real estate market correct recently along with industrial metals prices, wrote Van Eck Global’s David Semple in a Nov. 22 analyst note.

So while growth may be slowing, Western investors who have no exposure are missing out on an opportunity, according to the portfolio manager of Van Eck’s Emerging Markets Fund. China’s troubled real estate sector aside, Semple is focused on the long-term trends of rising incomes and an emerging middle-class—forces that he believes will drive economic output and domestic consumption for decades.

“Economic transition issues are complex and challenging, but media-fueled fears of an imminent, so-called ‘hard landing’ are exaggerated,” Semple wrote. “Seen through Western binoculars, investors run the risk of over-emphasizing the negative and missing the increasing importance of the Chinese economy, which we believe is grossly under-represented in most investors’ portfolios.”

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