Four Ways To Spot An Emerging Market

By Kapitall Wire Team AAA

The term emerging market is frustratingly ambiguous. Disconcertingly, it contains some – but not all – of the characteristics of a developed market. Practically speaking, it means the country in question has at least some liquidity in debt and equity markets. But how much? We generally apply the term to places that aren’t the U.S., Japan or Europe, and we invest there despite the risks because the returns are higher.

But development is a very complicated picture. There’s no one rubric for it. For instance, India is smaller than China, has slower GDP growth, and far fewer cities with at least a million people. But it also has much lower income inequality than China does, indicating it’s done a better job of distributing its wealth. When we compare it to a country like China, whose citizens are richer but whose growth has also been faster, how do we tell which is more “emerged?”

Characteristics of Emerging Markets

We decided to look for some reliable characteristics that we see in emerging markets that experts see as desirable. To do that we spoke to two fund managers with experience investing in and following the growth of these large Asian countries. Rob McIver of Jensen Investment and Christopher Tsai of Tsai Capital both emphasize long-term thinking, stability and exposure to Asian markets. Together we came up with four qualities that characterize emerging – or in some cases emerged – markets.

1. Ability to produce “aspirational products”

One of the foremost distinctions we noticed was the ability to produce, as well as the desire to consume, what McIver calls “aspirational products.” You can see this, perhaps surprisingly, in the success McDonalds’s Corp. (MCD) has had in China.

McIver thinks Chinese consumers still place a “’premium perception on dining at McDonalds,” he said, “and there are, in fact, parts of the world where the food at McDonalds is actually quite expensive relative to local options. And we see this continuing.” (For more on this topic, see: Luxury for Everyone.)

The performance of Nike, Inc. (NKE) in China tells a similar tale. The Chinese equivalent is probably the apparel company Li-Ning Co. Ltd., named for the famous Chinese gymnast. They rank third behind Germany's Adidas AG and Nike in terms of revenue generated in China. A lack of social capital is part of the reason Li-Ning has trouble competing with western brands. Nike, for instance, has more famous athletes representing them than you can count. And because Li-Ning’s “L” logo looks like the Nike swoosh, many Chinese felt that the brand – despite showcasing Chinese athletes – is an imitator.

2. A Middle Class

The size and growth of a country’s middle class is another important feature of maturing markets. Tsai believes the middle class is a smart way to play the long-term trend of emerging markets, where he believes food is a place to focus. “People, as they get more wealthy, want a higher quality of life. To most people, where that starts is by eating better, eating more protein and more meat.” It's no wonder that since liberalizing in the late seventies, China’s meat consumption has increased about seven-fold.  

"Middle class" means different things in different places, but it generally refers to the subset of your population that can spend between $10 and $100 a day. Depending on where you are, that is the amount of money that is enough to buy durable goods like cars and refrigerators. Now, middle classes are growing everywhere, but most of the growth is in Asia where the middle class is expected to triple over the next four or five years. (For more on this topic, see: The Finances of the Global Middle Class.)

3. Urbanization

One of the first things we think about when we think about development is the growth of cities, and this correlation is surprisingly strong today: the nations widely considered more “developed” have a much larger percentage of their population in cities. This trend played out gradually over the course of the 19th and 20th centuries; people slowly migrated to cities where employment is more diversified and hence often easier to find. The United Nations projects that this trend will continue until 2050, when more than 80% of the developed world is expected to live in an urban center.

Urbanization, particularly Asian urbanization, is one focus of McIver who has an interesting and subtle way of gaining exposure to it in his fund: elevators. The stock is United Technologies Corp. (UTX), but he’s most interested in one of the conglomerate’s subsidiaries – Otis Elevators – as a way to play China’s rapid urbanization. When it started to liberalize in in the late 70s and early 80s, the urban population in China grew by about a third, likely the fastest urban migration in history. It now has 59 cities with at least a million people.

4. Emphasis on top-line over bottom-line

A final, and more nuanced, development is definitely the delineation between top- and bottom-line goods. McIver sees a growing emphasis on the top-line products, particularly for healthcare equipment in China. One of the stocks in his portfolio is the syringe manufacturer Becton, Dickinson and Co. (BDX). When the company released a new, higher-end product with a device to keep doctors from pricking themselves, McIver noticed that Chinese hospitals were buying them in bulk over the cheaper alternatives. “We’ve been surprised at the prevalence with which some Asian firms have pushed high-end goods. [With Becton] we saw the Chinese leapfrogging the lower-end needles for the better ones.”

The Bottom Line

The term "emerging market" has been debated and is a notion that has evolved considerably over time. Some may call the term out-of-date entirely, an affectation of Western chauvinism. However, it’s clear that there are extremely long-term, observable trends at work that are hard to ignore. China hasn’t emerged yet, but the numbers show that it's on its way. By 2025 China will have twice as many cities with over a million people as the United States. The question then becomes how much longer until Chinese products, or Indian products or Turkish Products become “aspirational?” When will we get a Chinese invention like the iPhone? According to Tsai: “it may not be a telecom or technological innovation like the iPhone, but it’s only a matter of time.”

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