The Rapid Growth Of Emerging Nation Market Cap

Emerging markets are expected to play a much larger role in global stock market capitalization in the next twenty years. Although emerging countries only made up just 1 percent of global market cap ten years ago, this is expected to grow to 50 percent over the next two decades. See the following post from The Capital Spectator.

It's old news that emerging markets are expected to grow at rates in the years ahead that will make the developed world look stagnant. But the details still impress whenever new estimates are published.

The latest batch of numbers comes from Goldman Sachs, which predicts in a recent report that emerging markets could represent nearly half of global stock market capitalization in 20 years, as reported by the Financial Post. Currently, emerging market stocks are a small fraction of the world's equity value. Back in June, for instance, we crunched the numbers and found that the so-called emerging world held just 12% of global market cap. That's still a minor share, but it's up from around 1% a decade earlier. But even 12% is low once you consider that emerging markets harbor nearly half of the world's GDP, according to the OECD.



What's behind the rise of emerging market economies? Timothy Moe, the author of the new Goldman Sachs study, wrote that "the primary drivers are rapid economic growth and the maturing of equity markets that are at earlier stages of development," via Bloomberg. "Developed-market institutional asset management pools will need to increase their holdings of emerging-market equities."

Translated: the rich world will be buying more emerging market stocks in the years ahead, or so the report suggests. To be fair, lots of analysts have been arguing something similar for years. Based on the fundamental trend in the world economy, it's hard to argue otherwise.

The economies of China and India (to take the two obvious examples) have been expanding at much higher rates compared with the U.S. and the developed world. And more of the same is expected. China's GDP is forecast to jump by nearly 10% this year and more than 8% in 2011, according to The Economist. The outlook for India is almost as strong. By comparison, the U.S. will be lucky to grow by 3% this year and next, and even that looks appealing vs. the 1% GDP rise predicted for the euro region.

Another sign of the changes afoot comes in last month's news that China's economy surpassed Japan's for the first time.

"China and some other emerging markets have a number of positives going for them that don't exist in the advanced industrial economies," according to J. Anthony Boeckh in the recently published The Great Reflation: How Investors Can Profit From the New World of Money. Boeckh, a former editor of the highly respected Bank Credit Analyst, cites a list of plusses that make many emerging markets attractive. A few examples he notes in the book: undervalued exchange rates, strong fiscal profiles, highly liquid economies, strong underlying economic growth, and huge labor forces, to name but a few.

Is it any wonder, then, that emerging market stocks generally have soared over the past five years? The MSCI Emerging Markets Index has gained an annualized 12.3% through September 8, according to MSCIBarra.com. The biggest markets among emerging nations--Brazil, Russia, China and India (a.k.a. the BRICs) are up even more, posting an annualized 17% total return since 2005.

The developed world looks like a wet towel by comparison. The MSCI EAFE Index (a proxy for developed markets other than the U.S.), for instance, has risen a mere 1.2% a year in dollar terms. But even that modest gain looks good compared with the spare 0.1% annualized increase for MSCI's broad measure of U.S. stocks.

Emerging markets aren't so hot in 2010, however, advancing by a relatively mild 3.3% year to date through September 8. But in the current climate of diminished expectations, that's still enough to beat the slight loss in U.S. stocks and the 4% drop in EAFE.

The long-run outlook for emerging market stocks may be a no-brainer, but the near-term outlook is something else. Par for the course these days with risky assets. At least there's no shortage of strong choices for tapping into broad measures of emerging markets beta. The short list of funds (based on criteria set by The Beta Investment Report) provides seven solid choices for broad exposure, as shown in the table below.



And speaking of emerging markets, bonds issued by nations that fall under this heading have been a strong performer in recent years, and year-to-date performance is no exception. For example, the Citi Emerging Markets Sovereign Bond Index (Capped) is up an impressive 12.6% so far in 2010 through September 8. As broad betas go this year, it doesn't get much better than that. In fact, that's among the best performances among the major asset classes generally. What's going on? The short answer is that the combination of strong economic fundamentals in developing nations and the allure of bonds issued by countries with healthy balance sheets is a bullishly potent mix. Meanwhile, there are a number of compelling funds to tap into this brand of fixed-income beta, as the third table below shows.



Emerging markets, in short, have come a long way, but the journey's still in its infancy.

This post has been republished from James Picerno's blog, The Capital Spectator.