efficient markets, or is there something else going on?
From a diversification point of view, we can see that the best periods are in different time spans, and the best period for China was better than the best period for the United States. The worst 12-month period was 6% for China, ending in 1999, and –8% for the United States, in December 2008, just a few short years ago during the financial crisis.
Investment professionals sometimes measure risk by using standard deviation, the statistical measure. If we were measuring risk that way here, we’d conclude that the United States is probably riskier.
I don’t think the United States is riskier, but we must be careful in how we measure risk. When we’re looking back at empirical data, studying it, and thinking about statistics, empirical measures are not good enough. We also need a sound economic framework for what we’re looking at. It has to make sense.
I’m not sure it would make sense that someone would argue that China is less risky than the United States, but if all we’re looking at is volatility of returns or something like that, we might come to that conclusion.
How Do You Invest in China and India?
We’ve touched briefly on public equity markets, but another way to invest is through the commodity markets. You could invest in the companies in these countries, but you could also think about investing in the things their people consume.
Obviously, the commodity markets have been an important part of the story of the emerging markets. The graph below shows that there is significant risk from rising food costs. News about food costs has been all over the media lately, particularly in India.
We can see that in China and India, the average person spends about 30% to 35% of his or her income on food, compared with the United States, where that figure is closer to 5%. Rising food prices in China and India have a much bigger impact on inflation than do rising food prices in the United States. Rising food prices are thus a big risk in such countries as China and India.
If you wanted to own something that would do well if food prices rise, what do you think you would buy? Food. Agriculture. You might not think food prices would rise, but if you wanted to have something in your portfolio that you think would do well if food prices rise, you might think about food.
Other themes complement food, such as water. Making food requires a lot of water. Think about the countries that have a lot of water per capita; they can make the food and export it.
We also see China and India spending a lot more money on energy. If we consider electric power consumption per capita, China has just surpassed the amount of electrical usage per capita in the rest of the world.
Clearly, inflation is a big threat to these economies. We’ve seen a significant amount of inflation in the last 20 years. There has been more inflation in India than in China and certainly more in both than in the United States. For example, in India, what $1 bought in 1992 now costs roughly $4. In China, $1 in 1992 bought what now costs around $2.
The United States hasn’t had much inflation compared with China and India, where inflation is a big issue. Commodities would be a way to embrace that risk in your portfolio.
Another way to invest in China and India is through real estate. What ends up happening is a mass flux of urbanization in these countries. More people are living in the cities.
When you move from the farm to the city, you need a place to live. You might even want a Starbucks nearby. You probably want a bowling alley. You might want a restaurant. A lot of spending is going on — in construction, development, and housing. We’re seeing a ton of construction going on. Some people are saying that there is a real estate bubble, especially in China.
There’s a lot to say about all this. If, in fact, these trends continue, if people go from $2 to $4 a day, if we continue to see these countries grow, then there will probably be some increased need for housing and other forms of infrastructure.
In China, for example, approximately $2 trillion is expected to be spent on infrastructure in the next couple of years. On average, that’s about $300 billion a year. That’s more than what is projected to be spent in the United States. China is spending a lot of money on infrastructure.
Both Countries Diversify, But Are They the Same Thing?
People often talk about China and India as if they were the same, but they are very different. To see that, take a look at a breakdown of their exports. China exports a lot of manufacturing, more so than India. In contrast, India does a better job exporting services.
China is a net exporter, but India is a net importer. Both countries import a lot of energy and food. China is a net exporter that exports a lot.
Compared with other emerging economies, China is exporting a lot. That’s been an important trend for China and, I think, is an important one to pay attention to.
The cost of capital is also trending down in these countries. If you’re a business and you want to borrow money, the interest rates that you can borrow at are lower than they might have been in the past.
China and India are becoming less dependent on the developed world. It used to be that to attract capital, they’d have to raise their interest rates and then, maybe, we’d invest. Now, there’s a lot more going on internally in these countries.
China and India are less dependent on the United States and other developed countries, which is giving them a good environment for keeping their interest rates down. I think that’s helping their businesses in the private sector. Growth can definitely reduce dependence.
The following are just anecdotal examples. If you wanted to buy a car a few years ago, you might have bought a GM. For a computer, you would have considered a Dell, and for gas, Exxon Mobil.
Today, you think about Tata as a company you can buy cars from, Lenovo as the company for computers, and so on. There are risks associated with investing in these countries. The extreme good years and the extreme bad years are more significant and more pronounced than in the United States. You have to think carefully about how to put them in your portfolio.
Growth isn’t a zero-sum game. Good news for China and India doesn’t equal bad news for other countries. It means we can sell to them too. There are other things going on.
For example, in 2012, the number two market in the world for Rolls-Royce was China. Rolls-Royce sold a lot of cars there. That’s an interesting sign. What are the opportunities in that for other countries around the world?
China and India represent more than 14% of the world’s GDP. Together, emerging markets represent about one-third of the world’s GDP. The United States represents 20% of worldwide GDP. The emerging markets represent 33%; the United States, 20%. So, I leave you with a question:
How much exposure in your portfolio do you currently have, or should you have, to these countries that represent one-third of the world’s GDP?
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