Canadian Equities and Emerging Markets

It is hard to grow an economy without sufficient natural resources.Countries that have their own natural resources can exploit them, those that do not have sufficient natural resources need to buy them. Here in Canada, we are often told how important Canada's natural resources are to other economies.

As an example of how resource use patterns vary by country income class consider energy use. The chart below shows energy use (kt of oil equivalent) for high income countries (HIC), low & middle income countries (LMY) and upper middle income countries (UMC). Notice how energy use in developing countries has been growing steadily since the mid 2000s.

At the end of February the TSX composite index (represented by the ETF with ticker symbol (XIC)) broke  above its 10 month moving average indicating (hopefully) a new period of upward momentum.

The US equity markets have had a good run so far this year while the TSX has lagged behind. It is true that Canada does most of its trade with the US but from an investment in equities perspective, Canada's  fortunes are increasingly tied more to emerging economies. Here are some regression results from a model relating Canadian stock prices to the stock prices of EAFE, EM and USA. All of the stock price indexes are in US dollars. The regression is estimated in logs so that the estimated coefficients can be interpreted as elasticities.  The regression is consistent with a cointegrating relationship (residuals are stationary) and is best thought of as representing a long-run relationship between the variables. Notice that the coefficient on the emerging markets variable (EM) is positive and statistically significant. A 1% increase in EM increases the Canadian equity market by 0.81%. In this model, the other equity markets (EAFE and US) do not have a statistically significant impact on Canadian equities.

E7 vs G7

In an interesting article in the Globe and Mail, Ranga Chand makes a good argument for how the Group of 7 (G7) countries of Canada, France, Germany, Italy, Japan, the U.K.and the U.S. are being out paced in economic growth by the Emerging 7 (E7) countries of China, India, Indonesia, Brazil, Russia, Turkey and Mexico. As he points out, these countries now account for close to 31 per cent of world GDP, up from 19 per cent twenty years ago. During this same time period, the G7 has seen its share of world output fall from 51 per cent to 38 per cent.Over the past 4 years, the growth rates in the E7 countries are astonishing. Except for Canada, the G7 countries have not recorded much economic growth over this period.

While the E7 countries have recorded very impressive recent economic growth, their ability to use monetary and fiscal policy to help steer future economic growth varies considerably.  According to recent research done by The Economist, some of the E7 are in a good position to use monetary and fiscal policy to help shape their economy. The Economist has devised a "wiggle room index" which ranks emerging economies on how much monetary and fiscal flexibility they have. India, Turkey and Brazil are in the red zone (not much wiggle room), Mexico is in the middle of the pack while China, Indonesia and Russia each have plenty of wiggle room.

Rising CO2 emissions from China and India are a concern. Hopefully the Environmental Kuznets Curve (EKC) hypothesis applies to the E7. The EKC postulates a long-run curvilinear relationship between carbon dioxide emissions and income. At first, emission rise with increases in income, but after some inflection point emissions begin to decline.

China's Foreign Exchange Reserves

Due to strong exports and foreign investment into China, China has been piling up an enormous amount of foreign exchange reserves (currency, gold and special drawing rights with the IMF). Approximately 2/3 of these reserves are in US dollar assets (US treasury bills, US treasury bonds). A linear regression model indicates that China is accumulating an average of $33 billion per month.At the end of September 2011, China held $3.2 trillion in foreign exchange reserves.

A High CARBS Diet for Economic Growth

Thanks to Richard Park for bringing this important new acronym to my attention. Citigroup analysts have defined a new group of countries Canada, Australia, Russia, Brazil, and South Africa (CARBS).

"

What are the CARBS? They are the countries that combine very large commodity assets with high stock market liquidity. In many ways, they have exhibited similar characteristics so far over the course of the commodity cycle.

What have they got. The five CARBS economies have some 29% of the global landmass, inhabited by only 6% of the world’s population, and are thus disproportionately important as exporters of commodities. They produce between a quarter and a half of most key commodities."

The CARBS have a large share of the world's resource assets and a large share of global production of these assets. The increasing importance of resource scarcity and population growth indicates that resource exporters like the CARBS should do well in terms of economic growth.

Here are how the CARBS compare on a number of different indicators.

Comparing Emerging Economies with Developed Economies

Here is a short video from The Economist comparing emerging markets with developed economies.

Emerging Economies Taking a Greater Share of World GDP

In 1990, developed economies share of world GDP was 80% and emerging economies share of global GDP was 20%. The Economist has some nice charts showing how quickly things have changed in the past 20 years. Somewhere around 2019, emerging economies are expected to account for a greater share of world GDP than developed economies.

Solar lights the way in rural India

Here is a nice example of economic leapfrogging. With 300 million Indians without electricity and long waits for a grid connection, people are turning to solar.