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Investing for 2030: 4 Key Forecasts
12/14/2012 9:15 am EST
A report on 'Global Trends 2030' contains a raft of forecasts that investors can put to use. Here are some key predictions-and how to use them without getting burned, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
What do you, as an investor, do with predictions? Even well-researched predictions by experienced "predictors," like those behind the recently published Global Trends 2030: Alternative Worlds?
And most challenging of all, what do you as an investor do with predictions about which countries will grow most rapidly?
I think the default response-put your money into the financial markets in the fastest-growing economies-is actually wrong. Or at the least, the idea that "GDP growth equals market returns" isn't true, and it presents a trap you want to avoid.
Some Critical Predictions
Let me use some of the predictions found in this recent report to explain why I believe that, and how to put such predictions to use.
- By 2030, China will be the world's leading economic power-with the US second.
- The world's oil producers-especially Russia-will see their influence wane, in part because the US will attain energy independence.
- For the first time in history-as far as we can know-a majority of the world's population won't be impoverished. But half of the world's population will live in areas with severe shortages of fresh water.
- At least 15 countries will be at risk of state failure by 2030-Pakistan, Yemen, Afghanistan, and Uganda among them. Aging populations will slow growth even further in Europe, Japan, South Korea, and Taiwan. China and Brazil will have stepped up to new global roles, and Colombia, Indonesia, Nigeria, and Turkey will become especially important to the global economy.
Those are just four of the conclusions in the Global Trends report, a four-year effort by the US National Intelligence Council.
Some of the themes in the study-the economic rise of China and the rest of the emerging world, global aging, and a scarcity of water, for example-will be familiar to readers of my posts and 2008 book The Jubak Picks. (It's out of print but you can find it used on Amazon.)
In other areas-the risk of a computer network attack on global infrastructure that affects millions, or the possibility that a global health pandemic could reverse economic globalization-the study raised issues that I haven't thought about at any length (except in the occasional nightmare).
But to me as an investor, the most useful function of the study is the challenge that it throws down. What, if anything, do I as an investor want to do about these predictions?
Faster Growth Can Fool You
In some cases, I think the answer is relatively clear.
For example, in the case of global water scarcity, if the study is even just mostly correct in its predictions-and I think the evidence is remarkably strong in its favor-then you want to look for shares of companies involved in moving, purifying, conserving, and metering water. My most recent take on what stocks to buy on the water trend was in September (see "Water: Good as Gold for Investors").
I think responses to trends in the study-such as the growth of the global middle class and the rise in consumption of food and especially protein-are also relatively straightforward. Find companies that fulfill demand created by these trends and buy their stock.
But responding to other trends is harder-and in no case is it harder than with the very large trends in GDP growth during the period. What do you, as an investor, do about faster growth in China, Brazil, Colombia, India, Indonesia, etc., and relatively slower growth in Japan, Europe, and the United States?
The knee-jerk response is simple: You buy the markets of the faster-growing economies. You do it because economies with faster GDP growth show higher stock-market performance.
Very simple. And, current research says, very wrong. There doesn't seem to be much correlation between GDP growth rates and stock market returns.|pagebreak|
Germany Outperforms China?
The best-researched example is a comparison of Germany and China from 1993 through 2011. During the period, China's GDP grew at a real annual rate of 10.2% a year. Germany's real GDP growth was a piddling 1.3% a year.
And yet the return produced by the MSCI China Index during the period was a cumulative loss of 44%. The return for the MSCI Germany Index was a gain of 180%.
Astonishing, no? And other academic studies of the connection between GDP growth and financial market returns come to pretty much the same conclusion: There is no simple connection between GDP growth and market returns.
There seem to be a lot of reasons for this. For example, one peculiarity of GDP is that it doesn't distinguish between good (or efficient) growth and bad (or inefficient) growth. For example, the recovery from a storm like Sandy adds to GDP even though the storm and the recovery, when you net it out, might result in a decrease in national net worth.
Financial market returns, on the other hand, ultimately measure increases in net worth. From the point of view of a pure GDP calculation, a factory that increases production by hiring a lot of poorly trained and inefficient workers isn't better or worse than a factory that increases production by increasing productivity by adding better machines or hiring workers with better training.
In the short run (and the short run can last quite some time in a country with a large supply of surplus labor), what counts is the gross production from the factory, not the profitability of that production. In the long run, profitability raises net worth.
But one set of reasons that should be intensely interesting to investors is research showing that risk and the cost of capital are key to determining how GDP growth relates to financial-market returns.
I'd summarize the research this way: If a country with a high rate of GDP growth also has a high risk premium and a high cost of capital-perhaps because of political instability or a history of inability or unwillingness to control inflation-then the financial market returns will lag the rate of GDP growth.
I don't think this means investors should ignore differentials in GDP growth among countries. And it certainly doesn't mean you should ignore faster growth in a China or an Indonesia when you're building a portfolio and instead load up on low-risk but very-slow-growth Japan. (That would be a very odd view coming from someone who started a global mutual fund in 2010 in order to tap into global growth outside the US economy.)
But it does mean you need to rethink the way you try to profit from higher GDP growth rates in emerging economies.
The Right Way to Read Growth
How? In two ways.
First, when thinking about investing in national economies with high relative GDP growth rates-I'd call this the ETF approach, since it involves buying Korea or China or Brazil with the purchase of an exchange traded index fund-it requires that you think about the direction of the risk premium in that country as well as the magnitude of GDP growth.
Here's an example to think about. The return on the iShares MSCI All Peru Capped Index ETF (EPU) over the past three years is an annualized 14.29% as of December 12. The annualized return over that same three years for the MSCI China Index-which is tracked by iShares MSCI China Index (MCHI)-is a loss of 3.36%.
This is not explicable if you look only at GDP growth rates. From 2009 to 2011, Peru averaged real GDP growth of 5.5%, according to the World Bank. China's average annual real GDP growth rate from 2009 through 2011 was 9.6%
What happened during that period that partly explains the outperformance of Peru over China, despite the discrepancy in GDP growth rates in favor of China? I'd point to expectations. For China, growth of 9% was close to expected. For Peru, 5% was astonishing.
And I'd also note the steady improvement of Peru's credit rating. All three major credit-rating companies raised Peru to BBB (or equivalent) ratings by August 2012.
Moody's Investors Service, in its August upgrade, cited Peru's prudent fiscal and macroeconomic policies and the continued decline in the share of Peru's debt denominated in foreign currencies. (Less foreign current debt means less exposure for Peru to hot money flows from overseas investors.)
In contrast, worries over the health of China's banking system and over the overextended balance sheets of heavily indebted local governments have increased during that period.|pagebreak|
Putting It All to Work
As a working hypothesis, let me suggest that if you're trying to decide which relatively faster-growing countries in the Global Trends 2030 report to overweight in your portfolio, think about Colombia, Mexic,o and Turkey, where growth expectations are still relatively modest and credit quality is improving.
I'd also think about putting Brazil in this group: Growth has lagged so badly recently that expectations are modest. Yet if some of President Dilma Rousseff's structural reforms pay off, Brazil could see its traditional double-digit interest rates start to converge with those in the rest of the world.
I don't think this hypothesis rules out investing in companies in, say, China, or other countries with fast-growing GDPs. It does, however, suggest that the "buy-the-country" ETF approach might not be the best fit.
Think of it this way: If China is going to grow GDP by 8% or 9% annually in the next few years, do you want to own China or do you want to own companies inside or outside China that will be able to tap into that growth?
From this perspective, it doesn't matter whether your China exposure is from a US-based company such as Yum Brands (YUM) or from a China-based company such as snack and beverage leader Want Want China Holdings (WWNTY). You just want to own shares of companies with the biggest competitive edge.
So, second, when putting together a portfolio to take advantage of higher relative GDP growth in emerging economies, look for companies that are beating up on their competitors and/or who dominate their sector.
For example, in China's retail sector, you want to own Sun Art Retail Group (6808.HK in Hong Kong) despite its odd parentage as a venture between Taiwan's RT-Mart and France's Groupe Auchan.
In 2011, Sun Art moved to the top spot in China's hypermarket sector with a 12.8% gain, versus 11.2% for Wal-Mart Stores (WMT) and 8.1% for Carrefour (CRRFY). Sun Art is thriving-Wall Street analysts estimate 20% growth in profits in 2013-while competitors such as Tesco (TSCDY) are closing some stores and slowing expansion plans.
The key seems to be Sun Art's ability to run a Wal-Mart-style low-price megastore that is still attuned to Chinese tastes. For example: A Wal-Mart in Shanghai sells snacks at low prices, but its Sun Art competitor has a kitchen where customers can buy fried noodles and steamed pork buns just like they do when they shop in traditional neighborhood markets.
What other (potential) competitor-killers in fast-GDP-growth economies would I take a look at for my portfolio? How about cellphone tower operator IHS (trading as IHS.NL in Lagos, Nigeria), which has pioneered tower operation in a country with very unreliable power supplies and shaky security, but which happens to be one of the largest and fastest-growing markets for cellphones in the world?
Or Megastudy (072870.KS in Seoul), the largest of Korea's 28,000 "cram" schools? (When the Korean government recently cut back on the country's six-day school schedule so that Korean kids would have more free time and feel less pressure, Korean parents rushed to sign their offspring up for extra tutoring.)
And don't forget developed-market companies that have sunk deep roots in fast-GDP-growth economies. KFC parent Yum Brands is the biggest quick-service food operator in China-and has India in its sights.
Johnson Controls (JCI) has become a critical supplier to any automaker assembling cars in China. (Johnson Controls is a member of my Jubak's Picks portfolio.) Luxottica (LUX) is the largest retailer of designer sunglasses in China.
Investing in the future can be tricky, no doubt, but it is essential. After all, we're all going to live in the future one day.Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund owned shares of Johnson Controls as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund's portfolio here.
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