Middle class spread - how the global income shift affects your investments

By Tom Stevenson, 10 July 2008

In his latest column, Tom Stevenson explores the investment implications of a rapid expansion of the world’s middle class. How does it feel to be middle class? Here in the West, faced with soaring food and fuel bills, rising taxes, falling house prices and stagnant real incomes, the answer is probably: not so great.

In developing markets, however, the rapid emergence of a massive new middle class paints a different, and more optimistic picture – especially for investors who are alert to the opportunities this demographic revolution will create.

In emerging markets, hundreds of millions of people are poised to enter an income band which, for the first time, will give them an understanding of the phrase "discretionary spending". According to Goldman Sachs, 70 million people every year are joining the middle class, which it defines as an income between $6,000 and $30,000⁽¹⁾.

The impact on spending patterns, demand for natural resources and, as a consequence, investment opportunities will be immense because the lower end of this income range is seen as a trigger point for the purchase of many consumer goods such as TVs, washing machines and cars.

The middle class take a bigger share of spending

One consequence of this new middle class spread, is that a string of middle income countries such as China and India, but extending to less obvious candidates like Egypt, Iran and Vietnam, will take a progressively bigger share of global spending⁽¹⁾. 

Goldman Sachs, which has explored the implications of the middle class boom in a new research paper, expects middle income countries (excluding the 20% at the bottom and top of the heap) to account for 57% of global GDP within the next few decades, up from 31% today⁽¹⁾. That share has hardly moved over the past 45 years so its near doubling over the next 45 marks a significant change in the balance of the world economy.

It is the biggest shift in global spending patterns since the second half of the 19th century⁽¹⁾, when the emerging middle class in countries like Britain and the US moved out of relative poverty into an embryonic consumer society. The knock-on effects of this transformation are still visible today in the form of Victorian terraces and even the map of the world – the colonial land-grab in Africa was partly a consequence of the explosion in demand for natural resources that the emergent consumerism triggered.

What are the investment implications?

Three consequences of this expansion of the global middle class have clear investment implications:

• Changing spending patterns. Demand for different products peaks at different levels of income and growth in the "sweet spots" can often be much greater than expansion of the underlying economy might suggest.
• Increased pressure and competition for resources. Pressures on fuel, food, metals and water are unlikely to abate if Goldman’s projections are correct.
• Greater environmental degradation. A growing middle class is likely to exacerbate environmental pressures but also lead to greater calls for governments to legislate for a cleaner environment.

Investors need to be alert to the relationship between changing income levels and different types of demand. The $6,000 income level, for example, appears to trigger energy-intensive demand⁽¹⁾, which suggests that commodity pressures will remain particularly high in the shorter term. Further out, higher-end durables require a higher income, so car ownership, for example, rises most steeply when incomes are between roughly $10,000 and $20,000. That sweet spot might be a decade away. The growth of financial services such as insurance comes even later^(1).

Identifying the winners and the losers

Investors also need to bear in mind that these are predictions and will not necessarily come to pass. This income shift will also create winners and losers and, as we are discovering, the inflationary impact of massively greater spending power in developing countries can have a negative impact in the developed world where we feel the inflation but not the economic growth.

That said, a few investment implications seem unavoidable:

• Pressure on natural resources and so elevated prices seem likely to persist.
• Many of the best investment opportunities will continue to be in countries where the middle class is emerging most rapidly (or via companies in developed countries that are geared up to meet emerging market demand).
• Although China and India will play a key role in this transition due to their vast populations, many other smaller countries will experience equally dramatic transformations as their middle classes expand.

The Beleaguered  British middle class has been called the "coping class". Perhaps its time for investors to turn their attention to the developing world’s "shopping class".

 

Please note the value of investments can go down as well as up so you may get back less than you invested. Investments in small and emerging markets can be more volatile than other developed markets and changes in currency exchange rates may affect the value of an investment. The ideas and conclusions in Tom Stevenson’s weekly column are his own and do not necessarily reflect the views of Fidelity’s portfolio managers. They are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.

<sup>Source:
(1) Goldman Sachs, The Expanding Middle: The Exploding World Middle Class and Falling Global Inequality. Global Economics Paper No: 170, July 7 2008.

 Print this page</sup>