The ballooning middle class

Written By: Sanjay Luthra Associate Portfolio Manager, Global Equity AGF Investments

Sanjay Luthra of AGF Investments looks at the significant investment opportunities provided by a growing middle class and rapid technological developments in the Asia Pacific region

Emerging markets are growing at twice the rate of developed markets, and the primary stock market index representing the region outperformed many of its global counterparts in 2017, returning almost 28% for the year¹. Past eras may attribute this success to a surge in materials and energy, but a new set of opportunities are arising thanks in large part to the burgeoning middle class in China.

Emerging markets are no longer just a natural derivative on commodities, but rather a secular growth story offering broad-based investment opportunities, with some of the world’s most attractive up and coming tech companies.

Perhaps most staggering is the rate at which this transformation is occurring. While it took 10 years for the last one billion people to join the middle class, it is estimated that the next billion will be added in only six years². In fact, five people are now said to be entering the global middle class every second, leading us closer to a tipping point where the majority of the world’s population is identified as being middle class.

Not surprisingly, 90% of these new middle class entrants can be found in Asia Pacific countries and, in particular, China, whose middle class ranks have exploded in recent years. This is largely attributed to the country’s solid economic growth and concerted efforts to create a more balanced economy benefiting a greater share of its 1.4 billion inhabitants. China’s wage growth, for example, has climbed at double-digit rates between 2009 and 2016, and its labour income share exceeds the Organisation of Economic Co-Operation and Development’s (OECD) average3.

It’s not just an increase in wealth, however, that is driving economic change in the emerging markets. Demographics are also playing a part. The ballooning middle class in China and other Asia Pacific nations is now made up largely of young, tech-savvy consumers who are more interested in online entertainment, shopping, social media and gaming than past generations. Take Singles Day, for example. The newly created holiday encouraging singles to exchange gifts pushed e-commerce related retail transactions to US$25.3 billion in 2017, as compared to only US$19.6 billion on Black Friday spending in the US³.

Many of these purchases were made through mobile phones, which now act as handheld marketing devices through social media applications and gaming. As a result, more and more retailers are eschewing traditional television advertisements in favour of e-advertising as a way to promote their products and services.

This growing interaction with technology in everyday life is at the heart of China’s homegrown online ecosystem that has given rise to some of the world’s biggest and most profitable internet companies such as Alibaba Group Holding Limited and Tencent Holdings Limited.

Recent estimates suggest sales for Chinese internet companies will grow over 30% in 2018, this on top of 40% growth realised in 2017⁴. While this pace is unlikely to be sustained over the long term, opportunities are not necessarily overdone.

China’s online social ad mix was just 11% in 2017, compared to 25% in the United States. Meanwhile, China’s internet user level, at 774 million in 2017, is twice that of the US but its online advertising market was just US$50 billion in 2017, or 60% of what is being spent in the US⁴.

We see this shortfall as a potential catalyst for the Chinese online advertising market, especially towards social ads. According to eMarketer, online advertising will grow 25% annualised in 2018, over and above 27% growth in 2017.

The online gaming segment also poses an opportunity. China’s gaming base boasts over 583 million people, equal to a 70% penetration ratio2. China’s total game market revenue is expected to reach RMB 197 billion in 2017, with reacceleration of 24% in 2018.

China, and emerging markets as a whole, are a different opportunity set, in fact a leader in technology. As the Asian Pacific middle class continues to grow, we expect these opportunities will only balloon higher.

Commentaries contained herein are provided as a general source of information based on information available as of February 26, 2018 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Investors are expected to obtain professional investment advice.

References to specific securities are presented to illustrate the application of our investment philosophy only and are not to be considered recommendations by AGF Investments. The specific securities identified and described in this presentation do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable.

AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Asset Management (Asia) Limited (AGF AM Asia) and AGF International Advisors Company Limited (AGFIA).

AGFA is a registered advisor in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF AM Asia is registered as a portfolio manager in Singapore. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.

February, 2018

1. Bloomberg, as of December 31, 2017, represented by the MSCI Emerging Markets Index.
2. HSBC, October 2017.
3. Citi, January 2018.
4. Morgan Stanley, January 2018.