Sep 15, 2023, 12:33 PM ETInterview, Podcast

Emerging market equities poised to overtake developed market equities

Dual-Engine Growth: EM capital markets are projected to rise significantly due to two converging factors:
- Increasing EM GDP share.
- Rising equity market capitalization ratios relative to GDP as economies develop.
Market Share Projections (2023–2075):
- EM equity market capitalization share is forecast to grow from 27% currently to 35% by 2030, 47% by 2050, and 55% (majority share) by 2075.
- Developed Market (DM) share is projected to decline from ~42% currently to 27% in 2050 and 22% by 2075.
- US share specifically is expected to drop from 42% currently to 22% by 2075.

India:
- Currently accounts for 2–3% of global equity capitalization.
- Projected to rise to 8% by 2050 and 12% by 2075.
China:
- Projected to rise from ~10% to 15% by 2050.
- Expected to decline to 13% by 2075 due to adverse demographic outlooks compared to India.
Long-Term Economy Rankings (GDP):
- 2050 Projections: China, US, India, Indonesia, Germany as the top five largest economies.
- 2075 Projections: Seven of the top ten economies are projected to be current EM economies.

Demographics:
- Global population growth is declining from 2% annually (last 50 years) to 1% currently, projected to reach near zero over the next 50 years.
- While negative for short-term pension sustainability, slower population growth supports climate sustainability.
Market "Equitization":
- The primary driver of rising capitalization ratios is the transition of corporate assets from private/family ownership to public listing (higher share of assets quoted on exchanges).
- This factor is quantitatively more significant than the secondary driver of rising valuation multiples due to perceived lower risk.
Returns Outlook:
- Market cap growth does not automatically guarantee return outperformance; however, EM equities are expected to outperform over the long term due to:
  - Rapid GDP growth driving faster earnings growth.
  - Rising valuation multiples as GDP per capita increases and risk perception improves.

Policy and Globalization:
- Policy decisions regarding trade and capital flow openness represent the primary risk to forecasts.
- A reversal of globalization (e.g., increased protectionism, inward-looking policies) poses a major threat to projected capital market growth.
Current Signals of Stalling:
- Evidence suggests a stalling of globalization rather than a full reversal, though risks remain.
- Specific examples cited include Brexit (reduced openness) and recent trade tariff implementations.
- Supply chain "de-risking" taken to extremes could shift to a reversal.
China Specifics:
- Capital market opening in China has stagnated relative to earlier optimism, though this is a watch factor rather than the primary growth engine for EMs in the forecast.

Generative AI:
- Represents a significant upside risk to global growth and capital markets, though not formally included in baseline projections.
- Expected to boost Developed Market (DM) growth more than EM growth, potentially mitigating the relative shift toward EMs by share.
Investment Banking Implications:
- The "equitization" process in EMs is projected to drive substantial growth in investment banking activity as assets move from private to public ownership.
Investment Strategy Implication:
- The decade of US exceptionalism is not expected to persist over the next 10–20 years.
- Recommended strategy emphasizes global portfolio diversification with an increasing weight in EM assets.

Long-Term vs. Short-Term:
- Long-term forecasts (50+ years) are considered less susceptible to business cycle noise (e.g., recessions) than short-term forecasts, as they rely on slower-moving variables like productivity and population.
- Cyclical uncertainties tend to mean-revert over time, making long-term GDP determination more stable based on structural fundamentals.