IS YOUR PORTFOLIO POSITIONED FOR THE NEW WORLD ORDER?
There’s a lot of hyperventilating and paralysis amongst investors in this increasingly confusing market environment. From our perspective, what we can see is that people are essentially starting the new year in standby mode.
Uncertainty seems to have reached a fever-pitch amid all the news flow around a potential slowdown of the highly leveraged US economic boom, Brexit saga, the trade posturing, China’s alpha behaviour, and all the other headlines that keep adding to increased volatility.
Ironically, in an increasingly short-term focused environment, the best way to survive will be about your ability to cancel out the noise and to identify reliable, medium to long-term trends backed by real fundamental data.
What follows is a fairly simple outline of where investors can position themselves for what we believe may be the investment allocation of a lifetime: the convergence of global population and the economic world order.
The rising new world order
The below infographic provides some perspective on what the world’s top-10 economies may be in 2030 on a Purchasing Power Parity (PPP)-adjusted GDP basis.
It really got us thinking and what you are about to read is the result of this inspiration. Unless you are really close to all this, it may give you a few surprises such as:
India takes 2nd place as its economy more than quadruples mainly as a result of urbanisation.
The USA moves to 3rd place on a PPP-adjusted basis
France and the UK leave the top10 to make place for Turkey and Egypt.
As more people join the consumer class, GDP will converge with the share of population.
Indonesia is set to triple its economy, in Turkey’s case it could multiply almost 5-fold.
But the big question is: what does this mean for your portfolio…
Note that the above figures are on a Purchasing Power Parity (PPP)-adjusted GDP basis.
PPP makes the comparison between economies in US$ more fair as it calibrates for currency differences and purchasing power. This is also why It is often used by sophisticated investors to more accurately compare valuation levels between markets.
However, the PPP-adjusted top 10 looks different from the Nominal GDP top 10. For what follows, we will use Nominal GDP levels to further put into perspective how we can position our portfolios to capture this shift.
As investors we need to evaluate how and if we can benefit from the GDP growth of individual countries. A fundamentally sound way of doing this is to get an early entry into high-growth markets.
Follow the money: Market Capitalisation
While market capitalisation may not be the only way to evaluate potential growth, it certainly does serve as a good place to start because the more liquid a market becomes, the more capital it will attract from around the world.
The chart below provides us with evidence that performance and market capitalisation go hand-in-hand.
For example, only 20 years ago it was very difficult to get western investors to even entertain investing in places like China, India, Indonesia, or Brazil despite all solid evidence of real demand driven economic growth.
Today it is rare to find sophisticated investors without an allocation to these markets. What changed? Higher market capitalisation and liquidity draw more investors to the market which in turn attracts more local businesses to list themselves.
At the risk of stating the obvious, we know that that relationship between market capitalisation and performance are much like that of the chicken and the egg. In this debate, we like to take the side that market capitalisation leans more towards the chicken.
Is there a relationship between GDP and market capitalisation?
This is another ongoing debate and when we look at facts about this relationship between the 10 largest economies, at first sight, there doesn’t seem to be too much of a logic.
If there is anything we could take away from this chart, it would be that any economy in the global top 10 should have a market capitalisation roughly above 30% of the value of its respective GDP.
In fact, for 2017 the median ratio level was 94.95%.
But despite the random appearance of the chart, it does beg a question: Why is the capitalisation of the USA, Japan, the UK and Canada larger than their respective nominal GDP levels?
The likely answer probably has much to do with the fact that these are highly functional exchanges that host a large number of foreign listings.
In an attempt to better understand this, we pulled a chart with all the exchanges with a capitalisation level above their nominal GDP number.
Note that we left Hong Kong out of this chart as it’s 1274% ratio visually dwarfed the other exchanges.
Have you noticed over the past 20 years, for the more developed economies, there seems to be a trend where the MKT CAP/GDP ratio has been slowing down or even dropping while we observe how many of the emerging exchanges continue to grow in excess of their nominal GDP levels?
The average global ratio for the world lies at 112% as of 2017 which sort of echoes our previous observation of 94,95% of the top 10 countries in earlier on.
How to put this to work for your portfolio?
When got inspired to dig a bit deeper into this topic so we set out to find more research on GDP forecasts for 2030 and put them into perspective with today’s valuation levels.
In doing so, we came across HSBC’s report ‘The World in 2030’ We then used its GDP forecasts forecasts to plot what a market capitalisation/GDP ratio of 40% would mean for our markets of focus in terms of potential market growth.
We are assuming the 40% is rather conservative when considering that in general the MKT CAP/GDP ratios typically wind up at higher levels.
A more illustrative way to look at this data is as percentage of market capitalisation growth, considering the same MC/GDP ratio of 40%
What we can see is that there is a solid case for growth in market capitalisation for Bangladesh, Nigeria, Pakistan, Kenya, Egypt, and Turkey. We can’t help but notice that all these economies have 1 thing in common: they have large populations…
Furthermore, is it a coincidence that Kuwait, Saudi Arabia and Qatar, with low population levels, pose less growth potential?
What they have in common is that they have all amassed large capital pools as major oil and gas suppliers during the past 30 years, but apart from their current strategic global investment holdings, there doesn’t seem to be much upside from local demand. In fact, Saudi is burning through its reserves so fast that it will need to find a new way to replenish it coffers, but that is another story for another time.
Does the size of a country’s population really matter when deciding where to allocate your investments?
It’s an interesting hypothesis. It certainly merits a closer look.
At Silk Invest, we have a process of focusing on data and evidence rather than assumptions. We believe it is the only way to navigate today’s stormy waters of spurious headline-driven volatility.
What this means is that we now have to set out to validate this hypothesis of a convergence between population, GDP and what it would mean in terms of returns for investors.
If you are wondering where to find good value for the next 10 years, you may want to consider getting more familiar with these populous, yet under-researched markets. We are data driven and see through the international headlines thanks to our local presence in these places.
We’d love to be your guide, so if you interested in joining us on this discovery, a good way to start may be to subscribe to our email list so we can share more insights like these with you.