Working for a Living: A Report on Emerging Market Productivity

“If I have a handful of silver it is because I work and my wife works, and we do not, as some do, sit idling over a gambling table or gossiping on doorsteps never swept, letting the fields grow to weeds and our children go half fed!”

– Pearl S. Buck (from the character Wang Lung in Buck’s novel The Good Earth)

Arriving in Argentina’s capital city after a month-long journey across the United States, we are once again reminded of perhaps the most thrilling aspect of a developing market: that it is, indeed, developing. This, for value-seeking investors and gypsy newsletter writers alike, is a source of excitement one simply wouldn’t be without.

Much has been written on the subject of emerging vs. submerging markets, and with increasingly good reason. According to Goldman Sachs strategist, Timothy Moe, the market value of emerging market stocks is set to quintuple over the coming two decades, reaching some $80 trillion (with a “T”) by 2030. China, by this time, will have eclipsed the United States as the world’s largest market.

“The primary drivers are rapid economic growth and the maturing of equity markets that are at earlier stages of development,” Moe, as quoted in The Financial Times, wrote in a report Friday. “Developed-market institutional asset management pools will need to increase their holdings of emerging-market equities.”

Investors with an eye to the future, therefore, will want to be in the pool when the big money pours in. The ride will be rough, no doubt, but the waterline is most definitely rising. According to figures released by research firm EPFR Global, investors added money to emerging-market equity funds for a 14th straight week last week, even as they pulled $6.87 billion from global stock funds. The driver, it is clear, is the upward and ongoing growth, both registered and forecast, in emerging markets. The IMF expects the emerging economies to grow by 6.4% collectively next year, almost three times faster than developed nations which, reckons the fund, will likely dawdle along at a paltry 2.4%.

How do these nations achieve such veracious growth rates, puzzled politicians in the west want to know. Pearl Buck’s character, Wang Lung, answered the question in the quote above, but for the slow-minded policy wonk, we’ll simplify: They work. Moreover, their toils are of the productive kind – making cars, toothbrushes and belt sanders – as opposed to what the west counts as productivity – counting people, writing laws and tasering grandma at the airport. Put another way, producers outnumber parasites and factory floor hands outnumber Congress floor copouts.

Such a divergence in productivity is, of course, not lost on Mr. Market. Over the past decade the MSCI Emerging Markets Index has more than doubled. During the same period, the MSCI World Index of advanced nations has slumped nearly 21%. This worrying (for developed nations) trend expresses itself in entirely unsurprising forms:

Household Disposable Income

For economists fretting about “unfair trade imbalances” who have their knickers in a knot now, just wait until they see what’s coming down the pipes. When we attended the screening of Addison and Kate’s movie, I.O.U.S.A., in our then home country of Taiwan, we took the opportunity to quiz a few of the local audience members after the screening. One woman, clearly shaken by the movie’s warning against (ironically, unsustainable levels of American debt), winced: “I am scared. I don’t even save 50% of my income!”

Eventually, however, savers turn into spenders. Keeping up with the Changs or the Patels is just as much a part of human nature as is keeping up with the Joneses. At first it’s just a night out at the movies or a new handbag, then, before you know it, Mr. and Mrs. Chang are splashing out on a new ride.

Clearly, the winds of economic change are at the emerging markets’ backs. Yet, despite their uncompromising capacity for – and incredible track record of – growth, many stocks in developing economies trade at very competitive valuations. The MSCI Emerging Market Index is valued at 14.2 times reported profits, according to data compiled by Bloomberg. The MSCI World Index, meanwhile, trades for 15.1 times earnings. That may not seem like much of a difference, but remember that those are very broad measures. Drill down into individual markets and you’ll find that Russia, for example, trades for just 6 times earnings, as does the Middle East’s abandoned wonder, Dubai. Dig further and find individual Chinese, Indian and other emerging market companies, with impressive, double-digit growth rates, solid cash holdings and little debt, trading at even steeper discounts.

The rough and tumble, dog-eat-dog capitalistic initiatives coloring the emerging nations’ economic landscape harkens back to the “good old days” of the world’s developed economies; when entrepreneurial endeavourers were rewarded by the market, rather than punished by the state, when profit was a goal for which to strive in earnest, not a dirty word emblazoning the protest sign of a state-dependant layabout looking to borrow somebody else’s axe to grind.

So buy the Cash for Clunker economies if it helps you sleep at night…but don’t expect the hard workers in developing economies to share their handful of silver with you if you do.

Joel Bowman
for The Daily Reckoning