The path from a good investment theory to a good actionable investment is a tricky one. The other day Ben noted how investing requires both narrative and numbers, and neither alone is sufficient. One of the strongest big-picture investment narratives is the long-term growth potential of emerging market economies. As the developed economies of Europe and America struggle with heavy debt and weak demographics, so the story goes, the emerging market economies of Asia, Africa, and South America will be the ever-more important engines of global growth where the best investment opportunities lie.
At this level of generality, the narrative is probably true. But how can an investor act upon it? Consider that an investor who, on the strength of the emerging market narrative, bought the MSCI China Index at its launch in 1992 would now have a loss of 48% (according to Stephen Foley, writing in the Financial Times), while the S&P 500 Index has gained 386% during the same period. The MSCI China Index has performed poorly, in spite of the fact that during this time China’s gross domestic product (GDP) has grown by 1,780%. China is an extreme case of disconnection between actual economic grown and equity index performance, but according to the FT, the average correlation between a country’s stock market performance and its GDP growth is just 0.73 for the ten largest countries included in the MSCI Emerging Markets Index. A perfect correlation is 1.0.
Foley points out that emerging market indices are biased toward older domestic companies, which often are heavily regulated and state-owned. An exchanged traded fund linked to an India-specific index, for example, might therefore fail to tap the most promising avenues for Indian growth. Neither Coca-Cola (KO) nor Nestlé (NSRGY) are Indian companies, but both stand to profit from India’s growing middle class. Indians on average drink 12 eight-ounce bottles of Coke a year compared with 230 in Brazil and 92 bottles globally, according to the Wall Street Journal, and Coke plans to invest $5 billion in India by 2020. With more than one billion people in India, Coke could sell a lot of soda.
Nearly 50% of revenues from companies included in the S&P 500 Index derive from those companies’ non-US operations. Thus American-listed multinational companies can present some of the best opportunities for investing in emerging market growth.