Why I'm Banking on Emerging Financial Growth
by Carl Delfeld, Investment U's Global Equities and Emerging Markets Expert
Wednesday, April 6, 2011: Issue #1485
Some emerging markets are struggling so far in 2011.
But make no mistake; there are still plenty of global opportunities to capture vibrant emerging market growth. Our first step is to identify current trends, and the second is to choose the best strategy to tap into the growth.
While inflation in the United States and Europe is muted, it's alive and kicking in Asia and other emerging markets.
The current inflation rate in almost all rich countries is below 2%. (Australia and the U.K. are exceptions.) By contrast, the emerging market inflation rate is about three times higher. In India the inflation rate is 8.6%, and in China it exceeds 5%, with food inflation running at double-digit levels.
Higher inflation and governments raising interest rates to slam the brakes on their economies will be key themes in the coming year. Higher interest rates in emerging markets may be bad news for investors - unless they adjust their approach...
Three Reasons to Target Financial Growth in Emerging Markets
One promising strategy is to target emerging banking and financial companies.
Here are three primary reasons:
- Flexible proxies for growth and higher profit margins. Banks are great proxies for growth with their deep and broad tentacles stretched across the economies in which they operate. In addition, they have the flexibility to adjust their strategies and to pass on higher interest rates - actually boosting profit margins.
- Stronger balance sheets. Another key advantage for emerging market financial institutions is that they have relatively healthy balance sheets. This stability will allow them to weather any coming financial panics and to have the resources to penetrate untapped markets. For example, Asian banks are richly funded by the deposits of conservative savers. Such capital can be put to work as governments throughout the region try to reduce reliance on exports by stimulating consumer spending and lending.
- Focus on consumer financial services. Such focus leads to the more important reason to stick with emerging market financials - the rise of a consumer-oriented middle class. Until recently, Chinese homebuyers tended to prefer paying for a home with cash by using savings or borrowing from family and friends. After the recent rise in home prices, homebuyers are increasingly more comfortable taking on bank mortgages (though they need a 30% cash down payment).
The Backbone of the Emerging Global Middle Class
Mortgages, credit cards and auto loans are becoming increasingly popular among the three billion Asian consumers who are the backbone of a rising global middle class The rise of an Asian urban consumer with a higher income is likely to be matched by an increase in demand for financial products.
Each day, approximately 180,000 people in developing countries move from the countryside to cities such as Shanghai, Jakarta and Johannesburg. Each year, 75 million people from emerging markets join the global middle class.
They need all the basic financial services such as credit cards, bank accounts, mortgages and life insurance policies that we take for granted.
To tap these opportunities, you might want to look at the EG Shares DJ Emerging Markets Energy ETF (NYSE: EEO). It's a bit top heavy with its 10 largest holdings accounting for nearly 60% of the basket. Four are from China, three from Brazil, two from India and one is a South African bank. Unfortunately, many of these banks are state-owned and controlled.
Latin America's largest private bank, Itau Unibanco (ITUB) has $370 billion in assets and has a nice foundation to build upon with control of 11% of Brazil's retail banking market. It has an enviable five-year return on equity of 33.07% - versus an industry average of 12.37%.
The new frontier growth trajectory of bank and financial companies is an important emerging market trend. It will yield big dividends.