Over the last two decades, the emerging markets (EM) story has focused on unprecedented growth in China. That nation built a strong export-oriented manufacturing base and relocated some 400 million rural Chinese farm laborers into cities.
Today the EM story is moving beyond China. Due to dramatic wage growth, China can no longer be the low-cost producer for the world. Chinese hourly wages tripled in the last 10 years, taking them higher than most all of their Latin American and Asian emerging market counterparts. As a result, labor-intensive manufacturing has been moving out of China and into other EM countries, creating an economic spillover effect. We are now seeing a replay of the China growth story playing out in other emerging markets as the new factory jobs transition millions out of poverty and into the middle class.
The Brookings Institution estimates that globally, 140 million people are moving into the middle class every year, a number it anticipates to grow. Global middle-class spending is expected to increase by $10 trillion between 2015 and 2022, with approximately 80 percent of that coming from Asian markets.
By harnessing this burgeoning middle class, we believe U.S. investors can benefit from diversifying into emerging markets. EM economies are much more accommodative to growth, valuations are reasonable — if not cheap — and relative earnings growth looks attractive. On a simple price-to-earnings Ratio (P/E) basis, the MSCI Emerging Markets (EM) Index traded at a 30% discount to the S&P 500, despite much higher earnings growth prospects relative to the S&P 500, according to data through the end of September.
Earnings for the MSCI EM Index — a free-float-adjusted market capitalization index designed to measure equity market performance of EM — grew 18% in 2016 and are forecast to grow 30% this year, and 17% in 2018, based on Bloomberg bottom-up consensus estimates. By contrast, with S&P 500 companies near all-time high profit margins, and a tight US labor market, we see S&P 500 earnings growth as more compromised for the remainder of this cycle.
