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Mellon: The Borders Are Blending: Emerging Markets Consumers to Wield Buying Power


NEW YORK-It used to be that investors saw so-called emerging markets as deep pools of resources that helped fuel the powerhouse economies of Western Europe and the United States. Investing in international stocks seemed like a smart strategy, but only safe enough for a small portion of one's portfolio.

But the times, they are a-changin', and so are the roles of international-especially emerging-markets in the global economy, representatives from Mellon Financial's various asset management boutiques said during a presentation here last week.

"Today's emerging markets are tomorrow's consumers," said Andrea M. Clark, vice president and senior portfolio strategist with The Boston Company. Countries identified as "emerging" represent 80% of the world's population and 75% of the land mass-not to mention significant portions of labor and natural resources.

That has implications for both consumer and financial products as individuals outside of the United States amass more wealth and become more powerful economic presences, said Ron O'Hanley, president and chief executive officer of Mellon Asset Management.

Noting the high savings rates in Japan, increased affluence in Russia and Southeast Asia, and the dawn of consumerism in places like China, O'Hanley said: "This is not only an opportunity for investing, but a source of investors."

And Mellon is leading by example, with 70% of new clients each year coming from beyond U.S. borders.

At The Boston Company, Clark favors Japan and Western Europe, where changes in laws are affecting the way businesses operate. In Japan, for example, a decade of inflation and zero interest rates have stalled capital investments and consumerism. But inflation nudged up 0.1% last month, marking the first uptick since 1998, Clark noted. That may signal the start of Japan's reemergence onto the world stage, this time with $10 trillion in savings and a leaner economy.

Most importantly, a change in corporate law that will take effect in 2007 will, for the first time, allow foreign companies to buy stock in Japanese businesses. The result will be a flurry of mergers and acquisition activity, and abundant opportunities for investors.

In Western Europe, Clark said that widespread business restructuring has led to lower operating costs among European firms and less expensive labor, even in Germany, where labor unions control workflow.

France, where housing prices have risen 100% in roughly eight years, has restructured its mortgage market, which means new opportunities for financial companies. Housing prices in the United Kingdom and Ireland have likewise increased 150% and 200%, respectively, in less than a decade. Meanwhile, prices in places like Hong Kong and Singapore have dropped by half, leaving consumers there "massively over-leveraged," said Ciaran Spillane, who heads U.S. business for Newton Captial Management.

"This increase in leverage reverses the traditional relationship between debtors and creditors: the old debtor countries have become the creditor countries, and vice-versa," Spillane said.

The evidence of emerging economies revving their engines is perhaps nowhere more evident than in the energy sector. "The U.S. is not paying attention to reserves," Spillane said. Two-thirds of production is now in the Middle East and Africa. Of the remaining third, more than half of the energy resources are in Russia and the politically tempestuous Nigeria.

Already, Russia, which is said to have the world's third-largest natural gas fields, has begun importing from Saudi Arabia, he said. Right now, India and China, which represent 40% of the world's population, use only 5% and 10%, respectively, of the energy the U.S. consumes. Yet, increased stability and wealth in those countries is driving demand, and Spillane doesn't see that ebbing anytime soon. As a result, Newton is betting on oil field service companies, as well as companies developing alternative energy sources.

Most investors are severely underweighted in emerging markets, perhaps scared off by the 20% plunge of the second quarter, said Hugh Hunter, managing director and head of global emerging markets for WestLB Mellon.

Rather than problematic, that drop was cathartic, he argued. By pushing out many hedge fund managers, second-quarter performance left only long-term investors in the segment. Since then, emerging markets have not only recovered, but are up 20% year-to-date, he added. Hunter expects long-term investors to be richly rewarded.

"Emerging markets are here to stay," he said. Among his favorites are Brazil and South Korea.

In the case of Brazil, the recent re-election of President Luiz Ignacio Lula daSilva-a man who many worried would bring volatility in 2002-is seen as a sign of stability. Rich in natural resources, Brazil is also a major supplier of things like iron ore, soybeans and chicken to China, feeding the growing appetites of both industrialists and consumers in the world's most populous country. Strong exports are helping Brazil to wipe its once-staggering debt off the balance sheets. Consumer demand within the country likewise has been rising, and the gross domestic product increasing annually between 2% and 3%.

In South Korea, "world-class companies" like Samsung and Hyundai are selling cheap and performing well, he said. Also, the residents of the Asian nation are using a tool they never before have: debt. Again, these indicators suggest continued growth for Korean companies as they cater to consumers at home and abroad, as well as new opportunities for financial services firms.

Alan McFarlane, managing director for Walter Scott & Partners, questioned the continued use of the term "emerging markets." Instead, he suggested, what firms are finally addressing is a truly international economy. And that means more competition, less currency leverage, and a greater struggle to deliver the types of returns investors will demand. "The wealth-growth business just got much harder, not easier for the nest 25 years," he said.

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