The Goldman Sachs global economics team released a follow-up report to its initial BRIC study towards the middle of last month.
Just as the initial report focused on the growth potential of the so-called four BRIC (Brazil, Russia, India, China) economies, the new report takes the analysis one step forward and focuses on the impact the growth of these four economies will have on global markets.
The report focuses on the impact of these economies on global commodities (using oil as a proxy), demand for consumer goods (using automobile sales to make the point), and the impact on global capital markets.
While the main conclusions of the report are quite dramatic, one must keep in mind that these results ultimately depend on these economies delivering the high growth rates projected in the first report published about 12 months ago. The main conclusions of the report are as follows:
Over the coming years the strong growth profile of the BRIC economies and their increasing importance will push up trend global growth to over 4 per cent, compared to the trend of the past 20 years of 3.7 per cent. An increase in the global trend growth rate of this magnitude has enormous positive implications for the entire world.
The BRIC economies' share of world growth could rise from 20 per cent in 2003 to more than 40 per cent in 2025. Their total weight in the world economy will also rise from approximately 10 per cent today to more than 20 per cent within 20 years.
As the centre of global economic activity continues to shift towards the developing world, all market participants, whether they be investors or corporates, need to put together a coherent strategy to address this shift.
The number of people with an income over $3,000 (approximation of middle class) should double within three years in these economies, and within a decade over 800 million people will have crossed this threshold.
Never before has this type of scale been observed in terms of gross addition of numbers to the ranks of the consuming class. In terms of sheer numbers, it is equivalent to the addition of a new America and Europe to the global consumer class.
Within 20 years, there could be approximately 200 million people in these economies with incomes above $15,000 (as a point of reference that is more than the population of Japan). Therefore, the huge pickup in demand will not be restricted to basic goods but impact higher-priced branded goods as well.
Despite the balance of growth swinging so decisively towards the BRIC economies, the average wealth level of individuals in the more advanced economies will continue to far outstrip the BRIC economy average.
Goldman Sachs estimates that by 2025 the income/capita in the G-6 will exceed $35,000, only about 24 million people in the BRIC economies will have similar income levels.
China and India will emerge as the world's largest car markets over time. Within 20 years, China most probably will have overtaken the US as the world's largest car market. India will also displace the US about 10-15 years later.
Highlighting India's greater inefficiency in energy use, the data indicate that within 15 years India's contribution to global oil demand growth will overtake China's. India's share of actual global oil demand will also peak near 17-18 per cent, similar to China's.
The report makes the point that the emergence of the BRIC economies has already had an impact on global commodity markets, namely the impact of China. The huge price run-up in most industrial commodities is attributed to strong Chinese demand.
The next stage will be the impact of the huge emerging middle class in the BRIC economies on consumer goods demand, and finally longer term will be the impact on financial markets.
The interesting aspect brought out by the Goldman Sachs report and one which you increasingly hear spoken by global asset allocators, is the dramatic under-representation of these economies in the global capital markets.
The share of these economies in global capital markets is currently 3.5 per cent, and depending on the extent of capital market development, they could account for anything between 10 and 17 per cent of global equity markets by 2020.
Market capitalisation in the BRIC economies could increase by a factor of four times or $4 trillion (source: Goldman Sachs). While these markets will still remain dwarfed by the huge size and liquidity of Wall Street (despite such rapid growth), they will come close to approximating the size of Europe within 15 years.
If either of the above assertions is correct, then this should have huge implications for global capital flows and asset allocation trends.
In the world of low nominal returns I expect for the capital markets of the advanced economies over the coming decade, a large percentage of the incremental wealth created globally will occur in the stock markets of the developing world.
Imagine if in 15 years the stock markets of the BRIC countries really approximate Europe in size.
Is there any global portfolio investor positioned adequately to handle such a seismic shift in index weightings? Europe currently accounts for approximately 15-20 per cent of most global stock indices, compared to 3-3.5 per cent for the BRIC markets.
As the size of these markets converges over time, so too should their index weightings (some differences may persist for liquidity and free float reasons).
Can global long-only investors, wedded to relative performance, profit from this inevitable directional move, or will only the hedge funds (with no index fixation) benefit?
Given all the data above as well as the conclusions of the first BRIC report, can any asset allocator really justify having only about 3 per cent of his/her equity assets in stocks of emerging market countries?
Money has to move in this direction; the hedge funds, being more nimble and less constrained, have already begun to appreciate this fact.
The huge flows to Asia and more broadly emerging markets over the last 18 months, to me at least, are just the beginning of a multi-year trend.
There will obviously be cyclical ups and downs in these flows, but the secular trend is clear. More money has to flow into this region to properly represent its growing economic clout.
Do you want to be pre-emptive and anticipate this money shift or join the party later, when it becomes more accepted as conventional wisdom? Every institution has to make up its own mind.