Wednesday, December 29, 2010

Where to Invest Now for the Next 30 Years (Give or Take)

The largest economies 2011:

U.S., China, Japan, Germany, France, UK

The largest economies 2041: (30 years from now)

China, U.S., India, Japan, Brazil, Russia

If you have a long-term investment perspective and think globally about asset allocation, it may be time to review where you are invested internationally. If you are considering international investing you may want to consider a deeper analysis of these up and comers. Growth generated by the large developing countries, particularly India, China, Brazil and Russia could become a much larger force in the world economy than it is now – much larger than many investors currently expect.

Goldman Sachs issued an optimistic research report on global economies in 2003 which illustrated how China’s economy would overtake Japan’s economy as early as 2016. Well, they were right, kind of, it did happen, it happened in 2010. Maybe Goldman wasn’t optimistic enough.

A lot can happen over 30 years and there is a good chance that the right conditions in one or another countries economy will not fall into place and any projection will not be realized. However, if the BRICs (Brazil, Russia, India, and China) pursue sound policies (I’m talking mostly to you Russia) these projections may indeed become a reality. Remember, fifty years ago Japan and Germany were struggling to emerge from reconstruction. Thirty years ago South Korea looked a lot like North Korea looks today.

The progress of the BRICs will be critical to how the world economy evolves; they could become a dominant force in generating spending growth over the next few decades.

As developing economies grow, they have the potential to post higher growth rates as they catch up with the developed world. China's economy during the past 30 years has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy, not to mention the green economy.

There is a well-known existing econometric model from Levine and Renelt (http://www.fordham.edu/economics/mcleod/LevineandRenelt1992.pdf) based on cross-country econometric research that explains average GDP growth over the next the next thirty years as a function of income per capita, investment rates, population growth and secondary school enrollments. This closely matches the Goldman projections (in parenthesis) which employ a very different technique. The results are as follows:

Brazil – 3.3 (3.7) Russia – 3.5 (3.9) India –5.3 (5.8) China -5.8 (5.6)

These numbers predict robust average growth for these countries over the next several decades. Higher growth may lead to higher returns and increased demand for capital in these markets.

What are the implications? Well, the weight of BRICs in investment portfolios could rise sharply. The movement of capital might move further in their favor and significant currency realignments would take place.

As we become a shrinking part of the world economy, the accompanying shifts in spending could provide significant opportunities for many global companies like Coke and Caterpillar. Being involved in emerging markets is likely becoming an important strategic choice for many firms large and small.

Therefore, being invested in and involved in the right markets –particularly the right emerging markets may become an increasingly important strategic choice. While international investing does not reduce portfolio risk by a significant amount, it is measureable. And it does increase a portfolios expected return slightly and in the long run that’s what equity investors are looking for – whether stocks are 20 or 80 percent of the portfolio.

CP Blakely - CFP®, CTFA, CMFC 12/2010

Sources: CIA The World FactBook, Global Economics Paper Number 99 - Goldman Sachs, American Economic Review Vol.82 pp. 942-963