Part 1 - Debt
Debt levels are elevated in much of the world but there are stark differences by country, which shapes divergent growth prospects. Policies followed by central banks in the aftermath of the global financial crisis did little to encourage the deleveraging1 of economies, although the location of debt appears to have shifted in many cases – from consumers to governments.
It is interesting to bear in mind that many Western countries have large government liabilities, including unfunded pensions. Taking the UK as an example, it has large liabilities sitting under public-private partnership contracts. We believe the Western world’s ageing populations will increasingly want to tap into emerging-market growth to try to pay for these increasingly unaffordable commitments.
How does this impact investment? Figures for private debt-to-GDP2 ratios show the difference between the US and UK (high but falling since 2009) and a number of emerging market economies. We think the key point to absorb is that there is much more scope for future growth in borrowing in Indonesia and India, and this should be highly growth supportive. Most developed economies have high debt burdens, but so do some emerging markets. We emphasise the need to be selective.
Part 2 - Politics
Emerging markets have historically displayed greater political volatility. Now we have Trump in the US, Britain’s exit from the EU and further potential challenges to the eurozone ahead. Arguably, we think political risk could be higher for certain Western economies than some emerging economies.
The direction of travel is a key investment consideration when assessing politics and corruption. For example, the prevalence of corruption in Nigeria is hardly a surprise, given the country’s stage of development.
The key factors we look at for political analysis are, firstly, whether the situation is improving or deteriorating, and, secondly, whether we can find companies with sufficiently good governance standards to be good stewards of our clients’ money. We have found this with some multi-national subsidiaries in Nigeria, for example but have not currently found attractive opportunities in Russia.
Part 3 -Productivity
Most emerging markets have the potential for ‘catch-up’ productivity, which contributes to raising economic growth, as technology and governance lessons are learned from Western economies. Reforms are currently observable in a number of emerging markets, including India, Mexico and to a certain extent China and Indonesia. This is in stark contrast to the direction of travel in countries such as Turkey and South Africa. Brazil has had some political change to show the impetus for improvement, but there persists a painful correction due to prior mis-management by governments.
Part 4- Population Dynamics
We have talked about the divergence we see, and continue to expect, within emerging markets. One of the main platforms of this argument relates to working-age populations. The likes of India and the Philippines continue to have rapid growth prospects ahead, with the relatively young workforces the key GDP growth drivers. Unfortunately, it is not the only consideration, and other factors need to be overlaid to provide an understanding of productivity growth (or contraction).
The UK is expected to see its workforce flat-line but only if one takes into account an immigration assumption made by the United Nations, which may now be out of date, given recent policy shifts.3Given high starting debt levels, unfunded pensions, and the recent failure to drive productivity growth, the outlook for productivity looks poor for most developed markets even with technological advancement.
For emerging markets, there are some countries with economic reforms (e.g. India), many countries with low levels of debt, and many with the potential for catch-up productivity (e.g. low factory automation levels in China), so we think the outlook is selectively brighter.
Part 5 - Protectionism
We perceive President Trump to be operating on a day-to-day basis at the moment. We know his apparent desires, but not yet what is feasible once the full consequences of his policies are considered. While the threat of a border tax adjustment remains, and would have negative consequences for countries that export around the world, we believe it would potentially be just as damaging for the US domestic economy. This is because by raising the cost of goods brought into the country, he would leave individuals with less disposable income for the consumer services that are the lifeblood of the US economy.
What about US manufacturing jobs? There are plenty of headlines, but we anticipate that this is more likely to be consistent with practices by the likes of Apple, which announced a new US$150m assembly plant in the US a few years ago to much publicity, while neatly overlooking its many billions being invested into the supply chain in Asia, particularly China. This investment of a whole supply chain ecosystem, such as for smartphones, will not move back to the US unless the economic advantages are stark. If they do move to the US, we would expect the new plants to be highly automated and that the cost of products in the US would rise significantly. It seems that Trump is lacking wider Republican support on the border adjustment tax, presumably for exactly the reason of such unintended consequences.
The cost of US manufacturing labour is still many times the equivalent in Mexico and China, once payroll and other taxes are considered. To our mind, a manufacturing job renaissance is likely to disappoint. There are only about seven million manufacturing jobs in the US, compared with well over 100 million non-manufacturing jobs. As such, while the aim to improve the prospects of the rust belt is admirable, the prospects of the other 100 million-plus is far more significant to the US economy overall. In addition, raising the costs of imported goods will reduce consumer income available for other forms of spending, such as services, unless productivity rises overall.
We are aware that the uncertainties are significant, hence our preference to avoid manufacturing companies in emerging markets as well as the more export-oriented economies and companies.
This is a financial promotion and is not investment advice. The value of investments can fall. Investors may not get back the amount invested.
- 1 The process of reducing the level of debt.
- 2 Gross Domestic Product- a measure of a country's growth rate.
- 3 Source: Newton, UN Population Information Network - World Population Prospects: The 2015 Revision, 30 April 2016.