Fidelity Middle East & South Africa

    21st Century Investment Themes

    The shifting sands of economic power

    At a glance:

    • The balance of economic power in the world continues to shift towards emerging markets.

    • Emerging market consumption will be a defining theme of the next two decades.

    • In terms of increased growth contributions, the focus will move beyond established stories, such as China, to other emerging markets capable of growing strongly from a lower base.

    • Huge debt burdens in developed economies are constraining their economic potential, accelerating the shift to a two-speed world in economic growth terms.

    • The US dollar’s position as the world’s dominant reserve currency is likely to be increasingly challenged.

    • US hegemony is fading but investors should not write off investments in developed markets, where many companies retain an edge in high-value industries.

    • A diversified equity strategy remains sensible. One that allocates more to emerging markets to reflect their growth potential; but one that also retains an exposure to the innovative corporate sector in developed markets.

    Shifts in the balance of economic power have created a two-speed world in economic growth terms as emerging markets like China, India and Brazil continue a transformation that two decades ago would have seemed unthinkable.

    So, what do the next few decades have in store? The industrialisation of emerging markets will broaden out, benefiting other countries and lifting more people out of poverty and into the consuming classes. Meanwhile, much of the developed world is likely to see slower average growth rates as they struggle with high debt burdens. The US dollar is likely to be increasingly challenged as the dominant reserve currency.

    In broad terms, targeting investments to emerging market growth remains sensible and many investors remain under-exposed to these areas. That said, economies like the US are far from being yesterday’s news and energy self-sufficiency could act as a powerful growth driver for a North American renaissance.

    The power-shift continues

    The rise of emerging markets, the impact of globalisation and a historic transfer of wealth from west to east continues to transform the economic and investment landscape. At the same time, bloated debt levels, fiscal deficits and ineffective politics have produced a more challenging growth outlook for developed economies. As the chart (below left) plainly demonstrates, the economic world has become unquestionably two-speed. This split between fast-growth emerging economies and slower-growth developed economies will continue to shape the investment outlook for the next decade and beyond.

    The catalyst for this power-shift has been the sustained growth of the larger developing countries, such as China, India, and Brazil, which is forcing a re-balancing of global economic activity. It means that, by 2050, we are likely to have a very different-looking ‘top 10’ economies (see chart right). China is virtually certain to be the largest economy in the world; the latest figures from Goldman Sachs suggest China may overtake the US by 2026 . India, Brazil and Russia are expected to leapfrog all the advanced economies bar the US by 2050, relegating Japan to a lowly 6th place in the economic league table. It is clear that the world’s centre of economic gravity will continue to move inexorably towards the emerging markets over time.

    Taking stock of the power-shift

    Goldman Sachs recently considered the long-term economic outlook for a broad universe of more than 70 countries, which accounts for 90% of global GDP.1

    Halfway there: They conclude that the shift in the rebalancing of global GDP towards emerging markets remains a key secular trend. China, Russia, India and Brazil combined have moved from 11% of world GDP in 1990 to around 25% currently; this is forecast to grow to 40% of GDP in 2050. This means we are only halfway through the rebalancing process. India is expected to deliver the highest rates of growth from 2020 to 2050, enabling it to boost its contribution to global GDP.

    Some of the most significant (and most surprising) changes in the largest countries’ contribution to global growth have already occurred. Over the past ten years, China, Russia, Brazil and India contributed nearly half of the world’s growth (emerging markets contributed 70%) which was double their contribution in the 1990s. This contribution should hold at these high levels but the dramatic change which that initial shift represented is unlikely to be repeated by these same countries. In short, the emerging markets are already driving global growth, with the shift accelerated by the financial crisis.

    Rapidly expanding consumer middle class: The rebalancing of global growth is having an unprecedented effect in terms of lifting people out of poverty into the consuming classes in emerging markets. Over the next few decades, the number of people considered to be in the ‘global middle class’ is projected to more than double, with most of the new entrants coming from China and India. Goldman expects domestic consumption in the major emerging markets of China, Russia, Brazil and India to overtake the Euro area by 2013 and the US by 2023. The growth in consumption driven by a rapidly expanding middle class in emerging markets is set to be the defining theme of the next two decades.

    Focus will broaden out beyond the largest markets: Other emerging markets are now set to become more significant players on the economic growth stage. The chart (below left) shows that as the very high rates of growth in the BRIC countries tail off, other emerging market economies like Mexico, Indonesia and Nigeria will take over the baton. Indeed, Goldman Sachs projects that by 2050, the ten most populous African nations could grow to 15 times their current size, and Nigeria could become almost as large as Germany. Intuitively, there is certainly more potential for these economies to industrialise from a low base. Investors should ensure their portfolios have exposure to this wider emerging market universe.

    Wealth catch-up will take longer: The changes in GDP levels over the next 30 years will be dramatic, but the catch-up in income and wealth will be a more gradual process. In 2050, the G7 countries will remain the wealthiest economies in terms of GDP per capita. However, the considerable gaps between regions and countries will begin to narrow as inequality narrows across geographies (although not necessarily within countries). Russia’s GDP per capita is expected to grow strongly, while Korea will enhance its relative standing. With wealth more important than size for bond investors, economists suggest that Korea’s sovereign rating could be up-rated to AAA prior to 2050.

    “The real long-term growth story that investors should be getting excited about is consumption. Strong and consistent GDP growth in recent years is seeing rising incomes and a developing middle class in many economies. There is considerable scope for consumption growth throughout the emerging markets universe.”

    Nick Price, Portfolio Manager, emerging markets equities

    A new reserve currency?

    The US dollar is the world’s dominant reserve currency, but that position is likely to become increasingly challenged. As the chart (below left) indicates, the US dollar and the Euro make up 90% of ‘allocated reserves’ globally. However, ‘unallocated reserves’ have grown rapidly in recent years suggesting unwillingness on the part of central banks to allocate further reserves in dollars.

    In recent years, as emerging markets have grown and the US dollar has shown periods of sustained weakness, Russia, China, and some Gulf countries have expressed a desire to see a new currency system replace the dollar as the world’s reserve currency.

    Many commentators see the Chinese renminbi (RMB) as the main contender as an alternative to the US dollar. At present, the renminbi cannot be used as a reserve currency since the Chinese government maintains capital controls on its conversion. While the government is taking steps to steadily internationalise the currency, Chinese President Hu Jintao has stated it will be a long process. Ultimately, to be accepted as a genuine reserve currency, the renminbi would have to be fully convertible and allowed to float freely against other currencies, with lending and borrowing rates more transparently reflecting market realities, instead of being tightly controlled by the Chinese state.

    The development of a large, liquid, open bond market is necessary for the establishment of a reserve currency. Renminbi-denominated bond issuance has increased significantly from a very low base over the last two years, with the Hong Kong offshore ‘dim sum’ bond market acting as an international launch pad. In August 2011, McDonald’s became the first foreign (non financial) company to issue renminbi-denominated bonds in Hong Kong. Many other international companies have followed suit. The process of internationalising the renminbi is underway.

    Support for such a change has come from key international bodies, but it may not be a case of simply replacing one reserve currency with another. The UN called for a new reserve currency to be based on the IMF’s Special Drawing Rights (SDRs), which would be managed by a new global reserve bank. SDRs are claims on currency held by IMF countries which can be exchanged for Euros, Yen, Sterling or US dollars. The IMF released a report in February 2011, which stated that using SDRs could help to stabilise the world economy.

    Steady depreciation of the dollar has become something of an accepted wisdom. But nothing is guaranteed. History shows that once a reserve currency has established itself, it can be very resilient often outlasting the economic importance of the country of origin. Indeed, there is a case for continued dollar hegemony based on the ability of the US to become energy self sufficient. The commercialisation of extensive shale hydrocarbon deposits would allow the US to significantly reduce energy imports (and increase exports), which would substantively repair its trade deficit and support the dollar.

    The power-balance is shifting, but the US can still prosper

    The rebalancing of economic growth is well-established and the dollar is likely to be increasingly challenged as the dominant reserve currency. The implication of declining US influence and a challenging economic outlook also seems persuasive. But, the obituaries are premature. Investors who subscribe to the power-shift thematic should be careful not to write off the US as an investment proposition.

    While, China is likely to become the largest economy in the world within 15 years, the US will remain the wealthiest economy and a productive corporate and consumer powerhouse. The US has three supportive fundamental pillars in the shape of its demographics, its natural resources, and its corporate culture.

    • The US has good demographics for a developed country with a growing population and a labour force that is not aging as quickly as those in Japan, Germany and China.
    • The commercialisation of large fields of shale-based oil and gas will enable the US to become energy self-sufficient, perhaps as soon as 2020. The US is already the fastest-growing oil producer in the world.2 North America also benefits from the lowest-cost natural gas feedstocks in the world. This energy could provide a foundation for the production and export of energy-intensive goods from petrochemicals to steel.
    • The US corporate sector and business culture can lay serious claim to being the best in the world. Any list of the top 100 companies in the world remains heavily biased to the US and some of the most exciting companies in the high-tech fields are American. The entrepreneurial culture is well-established and, while the huge amount of internet start-ups may have produced many failures, it also produced Google, Amazon and Facebook.

    A diversified approach to emerging market growth

    While the rebalancing of global growth towards emerging markets remains a defining theme, playing the growth in emerging markets will become more layered. Single-country plays may become less obvious as a host of new growth engines appear and a diversified approach becomes essential. Economies like China have made remarkable strides already, but history suggests growth cannot be sustained at such high levels for very long periods as ceilings are reached in productive capital investment. Other emerging markets look set to take up the faster-growth baton. As workers demand higher wages in China, for example, other emerging markets with lower-cost labour forces, such as Vietnam and Nigeria are increasing their manufacturing base.

    The emerging market universe comprises countries at very different stages of development with a range of demographic profiles and varying natural resource or labour advantages, as well as a complexity of political considerations. Low-cost manufacturing is fluid and gravitates to low-cost labour markets. Continuous investment in research is critical to uncovering the best opportunities.

    “From a portfolio perspective, frontier markets such as those in Africa have excellent growth and consumption potential and are considerably less correlated with developed markets than is the case for more established emerging markets.”

    Nick Price, Portfolio Manager, emerging markets equities


    We are moving inexorably towards a future economic landscape that will be increasingly dominated by the emerging markets. Some investors have recognised this shift, but in many cases, investment portfolios do not yet reflect the shape of things to come.

    The emerging markets story will broaden out beyond the largest markets, as other economies increase in importance. This will warrant broader consideration of a wider emerging market universe for many investors. Markets tend to reward shifts in trends, not necessarily the continuation of established trends. With Brazil, Russia, India and China now well-established, attractive opportunities abound in the wider emerging market universe, with new engines of growth set to emerge across Latin America, Africa, the Middle East and Asia.

    1. Source: Goldman Sachs. GS Global Economics Paper No 208. “The BRICs 10 years on: Halfway through the great transformation”.
    2. Source: Citigroup. ‘North America as the new Middle East’; ‘Resurging North American Oil Production’. February 2012.

    Important information

    The value of an investment can go down as well as up so you may get back less than you invested. Overseas investments are subject to currency fluctuations and emerging markets may be more volatile than established markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. This information does not constitute investment advice and should not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment.