Living in a material world

We’ve heard about this trend for years. People in the most populous countries on earth are entering the middle class at a rate unseen in the history of the world. Companies are scrambling to capture the business of this mass of new consumers.

As people rise to the middle class, the changes in their behavior patterns closely mirror those experienced by Europeans and Americans as wealth spread in the wake of the industrial age. What is different about this phenomenon is the sheer number of people involved and the speed with which it is taking place. While the rise of the middle class in the United Kingdom and United States occurred over long stretches of time, in emerging markets the creation of large pools (tens of millions) of middle class spenders is now happening in just a few years.

So let’s step back and consider how we as investors can take advantage of this trend. Let’s think about creating a hypothetical basket of consumer stocks. I like to begin this selection process by first picking apart what I call the anatomy of the change.

The increasing wealth of emerging market societies over the past decades has found its way to the people, and vast numbers of them are now escaping minimal subsistence or poverty and are almost immediately becoming middle class or upper class, enjoying consumer goods, services and luxury items.

Rural farmers are moving to urban high-rise apartments. As people move from subsistence-style shelters to more middle class styles of dwelling, we see an increased demand, and therefore price, for the base metals of iron, copper and aluminum, as well as wood and concrete. Over the last decade, we have seen the stocks of businesses that sell these materials rise in tandem with the increase in the number of middle class consumers. So into our basket go the stocks of construction and engineering companies and providers of flooring, plumbing, paint and cabinetry.

Increased energy usage follows. And because these countries still lack a degree of technological sophistication, the energy usage is far less efficient than in the developed world. Let’s add a few energy and electricity stocks to the basket.

As people move into the middle class, they begin to change their diet, eating more complex and protein-rich foods. This trend increases demand for farmland and fertilizers. Add some chemical stocks.

Next, as people begin to do more than simply make ends meet, their demand for discretionary, or nonessential, goods and services increases. We have seen this trend play out in the increased demand for entertainment, cell phones and tablet computers. So let’s add discretionary stocks.

And finally, as a wealthy class emerges, wealthy consumers begin to purchase traditional luxury goods. German luxury cars rise in popularity and the desire for expensive restaurant fare increases, as does interest in designer clothing, shoes and wine. The wealthy, and especially those in the top 10%, also begin to look for a place to park their assets. Financial services is still a largely underserved market, but it is developing at a rapid pace. People are looking for companies to manage their savings, and thus the need for money managers and salespeople is growing exponentially. So, let’s round out the basket with a mix of luxury goods makers, hotels and financial services stocks.

It seems obvious enough doesn’t it? But what we have to remember is that this trend has been going on for a while now. In the past 10 years, we have seen the widespread out-performance of many of these sectors that are linked to the growth of the middle class in emerging markets. So what’s really left? Are there any options out there for the investor who arrived late to this party?

Well, I would say yes. Many conditions that are prevalent at this time favor a discerning investor who pays particular attention to stockpicking.

  1. Correlations are in decline. Stocks are no longer trading in a pack. Fundamentals of individual companies are regaining importance. This drop in correlations affords investors the perfect opportunity to look deeper than an index and deeper than a sector to find the kind of stocks that we at MFS like to call the global leaders — the companies with established brands that research shows have the potential to generate sustainable above-average growth and returns because of the strength and durability of their business models.
  2. Domicile doesn’t matter anymore. Don’t be blinded by where companies are located. We need to remember that a company need not be based in emerging markets to profit from this trend of a growing middle class in emerging markets. It doesn’t matter where companies that cater to this growing consumer class are registered. What matters is where their business is coming from. That’s what investors need to determine, and if they can do so and follow the rise of well-made goods and services that are being snapped up by this emerging middle class, they will be well served.
  3. This increased global consumer spending is a secular, not cyclical, trend. That means discerning investors have the opportunity to find stocks that perform well in all market environments.
This trend transcends the business cycles that we so frequently talk and worry about. Through the drop in correlations, the market is telling us that sector and stock selection are going to matter more in the coming months or years of this cycle. These selections are going to matter more than being “invested” or being “not invested.” All in all, I believe an investor who is willing to do the research to understand this trend of consumerism gone global could possibly achieve excess returns. The key is the quality of products, the cost structure of the companies involved and the reach of the product lines, which could provide product diversification. This is an exciting trend, independent of both commodity cycles and interest-rate fluctuations.

No forecasts can be guaranteed.

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.


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