There’s a huge trend that could change everything for the global economy, US businesses, and investors. You just have to ignore how bad it looks right now.
In a recent note, Joe Quinlan highlighted the story of four middle class consumers in emerging markets and came to the conclusion that they exemplify the future of the world economy.
“In the end, the world has changed — and for the better,” wrote Quinlan.
“In the years ahead, the global economy will increasingly beat to the tune of Bo, Leyla, Philippe and Seema, and millions of other middle class consumers like them. This consuming demographic cohort remains one of the most powerful economic forces in the world.”
In a following conversation with Business Insider, Quinlan again stressed the growing importance of this growing middle class.
“There’s a global convergence of incomes happening as more and more people grow into this middle class,” said Quinlan.
“You and I are used to having everything — toaster, television, credit card — but many of these people in these developing countries are getting these goods for the first time. It’s a huge opportunity for growth and the demographics really give you a long-term look at what the economy can do.”
In fact, as Quinlan mentioned in his note, the transformation is already taking place. Retail sales in developing nations have more than tripled since 2000, going from $2 trillion to $6.5 trillion in 2015. And it’s only going to get bigger.
Quinlan said there is also a good way for investors to play this shift.
“Owning large US-based multinationals over the long-term is the best way to capitalise on this,” said Quinlan. “New consumers love brands, and are attracted to strong names. That means good multinationals with brand awareness should be able to capture a big part of this growth.”
Companies such as General Electric, Procter & Gamble, and Avon all stand to gain from this growth. Noticeable brands with strong businesses that can establish themselves in many countries.
Schmitz and Alwy’s analysis agreed that the idea of having a presence in a country now could help in the future.
“Still, entering these markets early builds important, long duration brand equity and serves as a seed investment to secure growth over the longer term,” said their note.
Recently though, emerging markets have had a tough go of it for a variety of reasons. Bill Schmitz and Faiza Alwy at Deutsche Bank had a good breakdown of the problems. Here are the analysts:
As a result of slowing GDP growth, rising inflation, lower commodity prices and general global growth malaise, the relative appeal of emerging markets has been justifiably compromised, with forward valuation multiples on EM exposed names broadly decoupling from the domestic players, further exacerbated by the lost earnings from translating and transacting sales and earnings back to US dollars which is driving negative earnings momentum.
Adding to that is the current currency pain that has been forcing even the best multinationals to take larger losses than the macro-environment would indicate according to Schmitz and Alwy. Here are the Deutsche analysis again:
Making matters worse for the developing markets exposed names, the rising dollar has and should continue to reduce sales, profits and cash flow. On average, companies with more than 20% of sales in emerging markets saw over 20% cumulative negative currency translation on average from 2012- 2016E vs. ~10% for developed market centric players, with further pain from f/x transaction as many of these companies have to source products denominated in dollars.
The dollar pain should eventually recede according to the note, but it has certainly made these multinationals less attractive.
Quinlan also said that investors need to ignore the current noise and not lose the forest for the trees.
“Look, good companies just in developed markets have gone through two World Wars, numerous crashes, disease outbreaks, and a whole host of other incredible strains but that didn’t mean you should abandon them,” he said.
“You have to keep your foot in these countries and keep exposure to them. There’s been ups and downs in the US and Europe too, it’s just part of the process.”
There are some long-term dangers as well, especially the political atmosphere towards globalization, but Quinlan believe they will also be overcome.
The payoff will be substantial according to Quinlan, investors just have to have the patience for this wealth to be unlocked.
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