Stocks markets are struggling at the moment and none more so than those of emerging markets (Brazil, India, Indonesia, Mexico, South Africa etc ), which, as a group, have recently underperformed developed markets. This is surprising given that emerging economies have been growing at a much faster pace and that this trend is likely to continue given their positive demographics, i.e. growing young populations unlike many developed nations which have both declining and aging populations.
What happens when a nation’s population declines and the proportion of people of working age decreases? Firstly, the production potential of the economy declines – fewer workers can produce fewer goods, although this may be partly offset by productivity gains and increases in the labour-force participation rate.
Consumer demand also falls as the burden of servicing the public-sector debt and supporting retirees falls on fewer workers and this reduces their disposable income, leading to a reduction in consumption. Demand suffers a double whammy as new retirees spend less than in their working years. And this combination of falling output and demand leads to lower economic growth.
Looking forward to 2020, a comparison of the ratio of retired workers to active workers for developed nations is not encouraging. Overall the average for the OECD is projected at one retiree for every three workers by 2020. In countries with particularly weak demographics – France, Italy, and Japan, there will be one retiree for every two workers. On the other hand, Ireland is projected to be in a better position than most at one retiree for every four workers.
The reality is that many developed nations face rising dependency ratios and the prospect of slow economic growth going forward. The outlook is further weakened by the fact that many of these nations have high debt-to-GDP ratios which further increases the tax burden on the working population as these debt levels will have to be brought down to sustainable levels.
On the other hand, those countries (mainly emerging nations ) with low dependency ratios have far better growth prospects and the investor who can tap into these growing economies should do well. How can you do this?
One way is to invest in global companies that benefit from selling goods and services into these growing economies. This partly explains why the shares of global exporters have done well in recent years. Alternatively, you can invest in companies quoted on stock exchanges in the various emerging markets. This is difficult for the average investor but there is a simple way – through an Exchange traded fund (ETF) which focuses on emerging markets.
The interesting thing is that global exporters have done well this year yet emerging market stocks have struggled with the associated ETFs down by over ten per cent year-to-date. This anomaly is unlikely to continue for long given the prospects for these economies. There is no need to rush but there is a case to be made for building up a position in emerging markets during this period of weakness.