The Big Picture For The Week Of August 19, 2012

by: Roger Nusbaum

This week I wrote an article for theStreet.com about the new EG Shares Emerging Market Domestic Demand ETF (EMDD). The idea is that this fund owns companies with products and services used by people on the ground in various emerging market countries. In related news Global X filed for consumer sector ETFs for Asia, Latin America and Africa.

In the early days of this emerging markets renaissance, maybe eight or nine years ago, investing in the segment required very little work relative to today. The segment has evolved because the stories on the ground in many of the countries has evolved.

A simple example can be observed with a 30,000 foot view of China. Over the last ten or 15 years there has been a serious urbanization as hundreds of millions of people moved to cities. Actually many cities were built to accommodate this migration of people who were seeking a better lifestyle, like maybe something they would think of as being an American-esque middle class lifestyle. They would get there by moving to new cities and getting jobs that were not agricultural jobs. As their finances improved, they came to have some amount of disposable income to buy consumer goods.

Along the way, the financial system evolved too. When growth was going great guns without any consideration for policy action to maintain the growth, things like over capacity or poor loan quality didn't really have any consequence but that is changing and will continue to change and the consequence will get ever larger.

There are other trajectories in China and other emerging markets have their own trajectories or arcs along these lines. That is to say the countries are evolving and so the segments within the markets will evolve too.

I write frequently about top down investing and the extent to which I believe in monitoring countries for these changes. The top down stories change much slower than the bottom stories for individual stocks... usually. I expect to write about a bottom up example in my next post.

One way to think of this might be the extent to which different sectors within these countries come to have headwinds where they once had tailwinds. As taken from above, for a while the banks in China could get away with risky business practices, like U.S. banks six years ago. But as also noted above, I don't believe that is the case anymore. Consequences for poor loan quality were not a headwind, but now they are.

If China no longer needed to build more housing, as an example, then materials companies would likely see their revenues and earnings decline. This would not have to fundamentally impact the extent to which they get more expensive calling plans for their cell phones or buy more cosmetics at the department store.

The question now for consumer stocks is whether from the top down they have the most tailwinds or perhaps better stated, the fewest headwinds. I tend to believe the demand behind consumer products will be steadier than things like GDP or PMI prints as there are literally hundreds of millions of people making more money than they ever have, and are living a far more modern lifestyle than they ever have.

If this theory is correct then the issuing of funds that target this idea would seem to be well timed. I will be most curious to see whether this stands up for Africa or whether it is still relatively early days in that part of the world.

Disclosure: No positions