Emerging Markets Middle Class Is on the Rise, Ready to Spend

The worldwide economic picture may be full of uncertainties but one thing seems likely: the demand for goods and services in the developing world will grow at an unprecedented rate as the emerging middle class rapidly expands over the next couple of decades. Currently, 70% of the global population resides in the developing world, where demographic changes, growth in wealth and income and exports are helping to propel people into the middle class at an unparalleled rate.

The world is undergoing a seismic shift as developing countries become the engines driving global economic growth. Compared to the developed world, economic trends throughout emerging markets are on the upswing. Overall, the government credit profiles in the emerging world are improving and their populations are young and urbanized with growing amounts of disposable income and unmet consumer needs.

In contrast, the government credit profiles in the developed world are getting worse, the populations are aging, the consumer industries, including housing, are overdeveloped and the people in these countries are saving rather than spending. In the years ahead these demographic shifts will drive revenue growth in a range of industries, from consumer goods to banking to construction. Much of this growth will come from the largest developing countries, Brazil, Russia, India and China, where the middle class is expected to double in the next 10 years.

Worldwide the middle class is gaining 70 million new members annually, which will translate into two and a half billion emerging middle class consumers over the next 10 years. 

Historic Perspective

Much of what is currently happening throughout emerging markets is reminiscent of Japan in the aftermath of World War II. After losing about 40% of its industrial base during the war, the country underwent an economic revolution in the 1950s. Investments poured in and Japan began producing everything from synthetic fibers to ships. People started moving to the cities for work and income levels soared.

With their newfound buying power, Japanese consumers gobbled up household goods. Between 1953 and 1955, sales of washing machines quadrupled, doubling again one year later. Demand for cars and televisions also exploded.

In China, we are seeing the same sort of exponential increase in demand for consumer goods as more of the population moves to urban centers. Currently, 47% of the Chinese population lives in cities and this figure is expected to grow to 63% by 2020. Since 1986, the average income of city dwellers has increased 15% annually, and much of this income is spent on consumer goods. This spending is supported by a wider availability of consumer credit–last year, credit card balances grew by 17%.

These spending trends are only expected to continue as the population gets younger and richer. By 2015, half of the population will be under the age of 35 while real wages are expected to increase to $5,900 per year from the current level of $3,500 per year. 

Acceleration Principle

Demand for particular goods and services explodes in emerging markets once income levels cross certain thresholds, changes in per capita average income are also monitored. For instance, once the average income crosses $10,000 per year, car sales generally take off, and after the average salary exceeds $15,000 per year, people start demanding long-term savings products, a trend explained by the Acceleration Principle.

According to this theory, as average income rises, the number of people earning above average income accelerates well beyond the % increase in average income. So, in a country where the average income is $10,000 per year 2.3% of the population will earn more than $15,000, but when average income increases 25% to $12,500, the number of people earning more then $15,000 will jump by 600%.

Over the past year, we have seen the Acceleration Principle in action in China, where per capita income rose 10% but car sales rose about 50% in the first six months of 2010.

'The Emerging Consumer' Investment Theme

After we identified the “emerging consumer” as an investment theme, we conducted intensive research and applied rigorous fundamental financial analysis to identify companies that are likely positioned to benefit from the shift. Secondary and tertiary players that stand to profit from the ripple effects caused by social, demographic and economic changes were also identified.

For example, pharmaceutical companies that sell drugs for hypertension and diabetes in countries such as India and China are poised for future gains. Why? Because as people move to the city and their income levels rise, their eating habits often change in favor of processed foods high in fat and sugar. And, at the same time they tend to exercise less. These changes contribute to weight gain and obesity, increasing the risk for diseases such as diabetes.

In the last decade, as India’s economy grew 7% annually and 400 million people entered the middle class, the country also achieved another milestone: It became the country with the highest number of diabetics. Today, 7.1% of the population suffers from the disease. The average age of diabetes onset in India is 43, ten years younger than in Europe, and an estimated 1 million Indians are expected to die from the disease this year, more than in any other country.

Final Word

Of course, there are risks that all emerging markets pose, just as they did in Japan in the aftermath of World War II. Throughout many emerging markets today, political risks, terrorism, as well as the possibility for speculative bubbles raise concerns. And the “frontier” economies in Africa, the former Soviet Union, the Middle East and Latin America present additional challenges.

In these countries, instability, war, limited property rights, weak rule of law, poor infrastructure and/or rampant corruption may threaten to undermine economic growth. Yet even in light of these risks, we believe that the economic growth and demographic shifts many developing countries are experiencing create an attractive environment for investment. Through our emphasis on thematic investing, we are focused on identifying undervalued securities that we believe stand to benefit as the global middle class continues to grow.

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