Asset Allocators: Have You Checked Your Emerging Markets Allocation Recently?

William Sterling

Global Strategist | GW&K Investment Management

Data suggest this may be a time for investors to tactically increase their exposure to emerging markets (EM) equities beyond the “wisdom of crowds” one-eighth weight target. For investors with low or minimal exposure to EM equities, it would be difficult to find a better opportunity to review that stance since EM equities have rarely been cheaper relative to U.S. equities. GW&K’s view is that:

  • EM equities look reasonably valued by historical standards and notably cheap relative to U.S. equities
  • The U.S. dollar appears poised for a multi-year correction, which should be positive for EM assets
  • Global equity fund investors face a potential ‘pain trade” based on their low exposure to EM equities

The Future is Already Here…

We have examined the relative valuation case for EM equities, based on both relative equity valuations and currency valuations. Both comparisons now favor significant exposure to EM equities, particularly for investors with a long-term investment horizon of five-to-ten years who are willing to look through short-term volatility created by U.S.-China trade frictions.

Starting levels of absolute and relative valuations have historically mattered a lot for future long-term equity returns. While there is no such thing as a “free lunch” in financial markets, if history is any guide the odds currently appear tilted in favor of EM outperformance in coming years. This is particularly true if long-term trend growth differentials continue based on well-established demographics and productivity trends. As a recent study by the Brookings Institute suggested, such trends point to a huge geographic distribution shift in middle-class consumer markets, “with China and India accounting for an ever-greater market share while the European and North American middle class basically stagnates.”1

The Brookings Institute projections for the next decade are staggering, with middle-class consumption by China and India rising by 2030 to more than 5 times that of U.S. middle-class consumption. Whether measured in terms of number of consumers or total spending, Asian middle-class consumption seems likely to dwarf that of the U.S. by 2030. To be sure, such projections have been around for a long time, including long periods when EM equities have disappointed. Assume, however, that such projections are likely to be true, as we do. Wouldn’t the best time to invest on that premise be precisely when relative valuations suggest that other investors are deeply skeptical?

Middle-class Consumption - Top 10 Countries, 2015, 2020, and 2030 (PPP, Constant 2011 Trillion $USD and Global Share)*

Country  2015 Share (%) Country  2020 Share (%) Country 2030 Shares (%)
U.S. 4.7 13 China 6.8 16 China 14.3 22
China 4.2 12 U.S. 4.7 11 India 10.7 17
Japan 2.1 6 India 3.7 9 U.S. 4.7 7
India 1.9 5 Japan 2.1 5 Indonesia 2.4 4
Russia 1.5 4 Russia 1.6 4 Japan 2.1 3
Germany 1.5 4 Germany 1.5 4 Russia 1.6 3
Brazil 1.2 3 Indonesia 1.3 3 Germany 1.5 2
U.K. 1.1 3 Brazil 1.2 3 Mexico 1.3 2
France 1.1 3 U.K. 1.2 3 Brazil 1.3 2
Italy 0.9 3 France 1.1 3 U.K. 1.2 2

*Note: The author’s definition of middle-class implies a range of annual income for a four-person household of $14,600 to $146,000.
Source: Homi Kharas, “The Unprecedented Expansion of the Global Middle Class: An Update,” Global Economy & Development Working Paper 100, Brookings Institute, February 2017.

A key question will be whether and when narratives that support the current relatively rich valuation of U.S. equities begin to change. For example, consider former Fed Chairman Alan Greenspan’s recent comments about the U.S. outlook. Warning of a “stock market aura” currently boosting growth, he predicts over the long run “growth fades very dramatically” because rising entitlements are “draining capital investment dollar for dollar.”2 Mr. Greenspan’s view may or may not turn out to be correct, but it is an example of how one very well informed market observer believes the economic narrative regarding the U.S. economy could shift in coming years.

In contrast, while China’s macroeconomic risks are well known and widely discussed, we believe that the dynamism of Chinese companies may be underappreciated by many investors. Consider this recent interview with Shopify CEO Tobias Lutke regarding innovation in China:

“A lot of innovation is coming from China. A lot of people have not realized that China has completely flipped on its head. It is not just copying ideas from the West; it is actually delivering new ideas like fully automated supermarkets that are coming to various cities all over China. What is life like in China? It is appreciably more futuristic than it is anywhere else by being a post-credit-card world through WeChat Pay and all these kind of things which are unlocking completely new business models for them.”3

Mobile payments is an area where China is clearly leapfrogging the developed world, with China having processed an astonishing $12.8 trillion in mobile payments in the first ten months of last year. While it is not an apples-to-apples comparison, the U.S. in 2017 had just $49 billion of mobile transactions.4

More broadly, a recent J.P. Morgan report made this comparison between U.S. and Chinese companies:

“China lags on aggregate, especially on spending on R&D, higher-end manufacturing (like aircraft), measures of innovation, as well as on its cloud and AI capabilities. That said, China has taken the lead in a variety of areas, ranging from e-Commerce, mobile payments, semiconductor consumption, share of super-computers, EVs, renewable energy, industrial robots, and drones.”

These topics could each be the subject of dedicated reports. The broader point is this: at current valuations, markets appear to be taking a rather extreme view of the risks of investing in EM relative to the U.S. In contrast, our team of bottom-up EM analysts sees dynamic wealth creation continuing not only in China, but in numerous other EM nations and industries as well. For those who believe, as we do, that there is still enormous potential for wealth creation in EM nations in coming years, the current valuation gap relative to the U.S. represents both a puzzle and an opportunity.

At the very least, beware of taking the last ten years of global market trends and using it as the baseline for the next ten years. As sci-fi writer William Gibson famously said: “The future is already here: it’s just not evenly distributed.”5

One way to think of the uneven distribution of the future is just to look at the following stunning visualization of the world’s population, which shows how small the U.S. population is in the global context.

Now ponder this: Ten years from now, how likely is it that the U.S. equity market will continue to represent roughly half of the world’s equity wealth when it accounts for only 4% of the world’s population?

Our guess: not very.


This represents the views and opinions of GW&K Investment Management. It does not constitute investment advice or an offer or solicitation to purchase or sell any security and is subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes.

Investing in securities or investment strategies, including the markets and/or any GW&K’s Investment Strategies presented in this document, involves risk of loss that clients should be prepared to bear. No investment process is free of risk; no strategy or risk management technique can guarantee returns or eliminate risk in any market environment. There is no guarantee that GW&K’s investment processes will be profitable, and you therefore may lose money. Past performance is no guarantee of future results. The value of investments, as well as any investment income, is not guaranteed and can fluctuate based on market conditions. Diversification does not assure a profit or protect against loss. GW&K’s active management styles include equity and fixed income strategies that are subject to various risks, including those described in GW&K’s Form ADV Part 2A, Item 8. GW&K’s Form ADV Part 2A may be found at or is available from GW&K upon request.

Indexes are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in an index. Index data has been obtained from third-party data providers that GW&K believes to be reliable, but GW&K does not guarantee its accuracy, completeness or timeliness. Third-party data providers make no warranties or representations relating to the accuracy, completeness or timeliness of the data they provide and are not liable for any damages relating to this data. The third-party data may not be further redistributed or used without the relevant third-party’s consent. Sources for index data include: Bloomberg (, FactSet (, ICE (, FTSE Russell (, MSCI ( and Standard & Poor’s (

© GW&K Investment Management, LLC. All rights reserved.


William Sterling

Global Strategist | GW&K Investment Management

PUBLISHED: July 15, 2019

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