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Finding growth in a low-growth world

Category: India, China, U.S.A., United Kingdom, Brazil
By Scott Berg, CFA – T. Rowe Price Portfolio Manager discusses the need to search deeper and broader to find sustainable global investment opportunities in this low-growth environment

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Meaningful macroeconomic risks in both the developed and emerging world are likely to lead to a period of low, but not collapsing growth. In this new low-growth environment, investors will be required to search deeper and broader for opportunities. Despite this uncertain environment, growth investors continue to identify exciting growth opportunities.

Developed world: E-commerce and technology provide robust growth opportunities

Growth investors with a large and diverse opportunity set, continue to see opportunities across the globe. One area of meaningful and long term market share growth that remains attractive on a global basis is e-commerce. In a low-growth environment, market share gains and pricing power arguably become more important as drivers of stock returns such as exposure to areas of the economy that are gaining a share of consumer spending. E-commerce falls into this category. Consumer spending has been in the low single digits for the last ten years. U.S. retail sales have only grown at 3% compound annual growth rate (CAGR) over the last decade. However, e-commerce has grown nearly 20% CAGR¹ – a clear market share gainer within an extremely large industry generating profits.

Importantly, e-commerce still only represents less than 5% of overall retail sales in the U.S. today (and less in most developing economies), implying that there is ample room to grow.

Another area that we find attractive is in the ever changing technology sector – successful product innovation tends to create pricing power, even in a low-growth world. We are particularly attracted to mobile computing where we have seen a large trend towards the convergence of computing devices.

Of course, periods of rapid technological change leave investors and analysts with the difficult job of avoiding the potential losers while identifying the likely winners. Understanding the nature of innovation, the speed of its advance, and likely responses from competitors, consumers and regulators, is crucial for investment.

Strong potential for alpha generation in emerging markets

Looking forward, we expect growth in emerging markets (EMs) to be dispersed by country as regional factors become more apparent, but for growth to remain robust across emerging nations in aggregate. Current market valuations reflect risk aversion and depressed earnings over the medium term. However our outlook is more optimistic than that implied by the market. Therefore, we believe that today’s starting point provides upside potential for many individual stocks.

What may surprise investors is how important EMs are to the global economy at present, and how this will become even more pronounced as we move forward. When we look at the GDP of emerging markets globally, around 35% of the world’s GDP derived from the emerging world in 2009 (Figure 1). Importantly, we are constantly looking forward, and while the EM proportion of GDP has increased to around 40% today, EMs share of global GDP is projected to surpass developed economies in a little over five years.

Our view remains that the market has yet to fully recognise the transformation that EMs have made over the past decade and the strides forward many countries have made in economic terms.

EM stocks are expected to be more volatile than developed world counterparts. This was in evidence during 2011 in a period when risk assets were out of favor and many stocks were de-rated. This does not, however, detract from the powerful themes that should continue to offer opportunities for growth investors.

One such theme is the emerging market consumer. The number of people in the BRIC countries (Brazil, Russia, India and China) with annual incomes of at least $6,000 (USD) is expected to grow by 70% over the next decade. The average annual income of Chinese workers grew by 35% a year from 2003 to 2010, while in Brazil the number of middle- and upper-class consumers has grown by about 50% since 2005². This emerging middle class should drive global demand for consumer products deep into the 21st century.

Another powerful growth theme is in EM financials. This is an area where we see a tangible difference between emerging and developed markets. Financials can in some respects be considered as a ‘levered’ investment linked to an underlying economy. A banking system operating within a growing economy with controlled non-performing loans (NPLs) is likely to be a good starting point if you wish to identify growing, profitable banks – we see many such examples in the emerging world today.

The valuations for EM banks are also favorable. This is important given the relevance to a good investment versus a good company, given valuation always matters. Encouragingly, many EM banks are trading at high single-digit to low double-digit levels when considering forward looking price to earnings ratios – this is not inconsistent with valuations for many developed world banks, despite their material differences.

A sustainable investment process. The heightened volatility equity investors have witnessed in recent times has undoubtedly been challenging. However, while an understanding of short-term volatility is integral to equity investing, successful long-term investing demands adherence to a sustainable investment process. Ultimately, identifying the best investment opportunities in a stock universe and applying conviction to those ideas within a diversified portfolio, provides investors with the strongest platform to deliver strong returns over the long run.

Quality growth stocks are frequently mispriced, especially in emerging markets. This type of anomaly occurs because many investors in the asset class have relatively short time horizons, while local investors lack the research capabilities needed to identify the most attractively valued long-term opportunities.

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¹ Source: census.gov

² Source: Deutsche Bank Research, BloombergFinance LP, Goldman Sachs Research

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