One of the most important reasons why the emerging markets can grow faster than the developed markets is that they are less levered than the developed countries both in terms of public sector and private sector debt levels. This factor is significant, as high and growing debt burdens act as a constraint on economic growth and impair a country's financial flexibility. As an example, Greece, Ireland and Portugal are all now set to experience deep austerity measures and public sector spending cuts due to high debt levels which will likely result in these countries experiencing sharply below-trend economic growth for several years. As is the case with these countries as well as other countries with elevated debt levels, high debt service burdens and elevated current account deficits negatively impact a country's ability to service their debt and experience strong secular growth.
Another factor supporting investing in companies tied to the emerging markets includes a concept we call "catching up." Emerging markets are picking up on a relative basis to developed countries due to improvements in education, infrastructure and productivity. Rising wealth has allowed emerging market countries to make significant improvements in both public and private sector education as well as invest in critical infrastructure throughout their countries. While poverty rates are still elevated and infrastructure is still lacking in many areas, significant progress has been made throughout the emerging markets to improve literacy levels and education and improve roads, bridges, airports, ports and railways. These developments support the secular trend of growing wealth and middle class "purchasing power" as these consumers "catch up" to the rest of the world.
Emerging markets have also embraced technological improvements and benefited from advancements and investments already made in the developed world. Emerging markets have shown a remarkable ability to transform and move up the learning curve at an accelerating rate. This combination of improvements and "catching up" has resulted in rising productivity, growing wealth and rising incomes. These developments have supported declining unemployment rates for the past two years in emerging market economies.
Importantly, improved literacy, job growth and infrastructure have accelerated a secular trend, which is already firmly in place "“ rising emerging market consumer demand growth. Indeed, consumption is picking up as fiscal and monetary stimulus is set to gradually fade. The "hand off" from government, business investment, and exports to the emerging markets' consumer is gradual, but nevertheless an important step in the emerging markets' eventual transition from developing to developed economies.
The benefits of attractive labor and resource assets allow emerging markets the opportunity to grow faster on a secular basis versus the developed markets. Over the past several years, select emerging markets have grown significantly faster than the developed markets.
This stronger economic growth profile is an important factor in picking "rising stars" because emerging markets' demand growth alone can significantly drive positive fundamental improvement in a credit. For all the above reasons "“ lower debt levels, expanding credit availability, attractive labor and resources, and favorable demographics "“ investing in credits tied to the emerging markets secular growth engine is a strategy we continue to believe in. While there are some cyclical risks in emerging markets, investors should focus on these secular themes and focus investments in areas that stand to benefit most from these positive long-term trends. The Cyclical Case (and Risks) for Rising StarsOur cyclical, or near-term, views remain favorable for emerging markets and for companies tied into strong near-term economic growth in emerging markets. In terms of our cyclical economic growth outlook, we expect emerging market economies such as Brazil, Russia, India, Mexico (BRIM) and China to grow real GDP at 5.5% to 8.5% and nominal GDP at 12.5% to 13.5% over the next year versus only 1% to 3.5% real GDP and 1.5% to 5.5% nominal GDP for the developed market economies, such as in the U.S., U.K., Europe and Japan. World real GDP we estimate at roughly 3.25% to 3.5%, and 6% nominal over the next year. The sharp contrast in the outlook for economic growth between the emerging markets and the developed markets is striking and supports an investment strategy which favors "rising star" companies linked to stronger economic growth in emerging markets.
The main macroeconomic risk for emerging markets over our cyclical horizon is inflation and how policy makers respond to rising food and energy prices. Global economic growth is "picking up" and emerging market growth is "running fast" causing concerns over rising inflation. To be clear, fiscal and monetary policies in emerging markets are set to gradually tighten. As evidence, fixed income markets are pricing in higher rates and tightening, particularly across the emerging markets. However, we believe emerging market countries are more concerned about the growth effect than the inflation effect of higher commodity prices, particularly in the case of oil. As a result, we believe emerging market countries are unlikely to raise rates aggressively, but rather will "tap on the breaks" gradually through a combination of increasing government subsidies, gradual emerging market currency appreciation and measured fiscal tightening measures. A gradual tightening of fiscal and monetary policy should prevent over-heating in the emerging markets. Nevertheless, inflationary risks are rising in developing economies and will remain a critical factor to monitor throughout this year.
In addition to specific investments in the emerging markets, we favor select investments in "rising stars" in the global banking industry given improving fundamental trends. As an example, core Tier 1 capital ratios for the major U.S. banks have improved significantly over the past several quarters. These investments stand to benefit from attractive yields in bonds with spread tightening potential given many banks are improving their balance sheets, de-levering and de-risking.
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