China and India plays for now, later, and much later

Consumers, it seems, are the key to everything economic -- and the more gluttonous we are, the better. (At least until the bill comes due.)

After all, we are (or were) 70 percent of U.S. gross domestic product. If that isn't one of the pillars of the 21st Century idea of American Exceptionalism, what is?

But then there's a school of longer range investment thought that sees a slow but permanent shift away from the power of the great American economy and consumer (and our fellow shoppers in the developed nations of the world) to our rapidly growing counterparts in emerging markets, notably China and India.

Those two nations alone account for roughly 2.5 billion people. Slice a fraction of that off, give them middle class incomes, hatchbacks, strip malls and access to The Home Shopping Network, and, well, you can see how the investment implications for the consumer stocks in those regions could be staggering.

"Roughly 75 percent to 80 percent of global population growth is occurring in emerging markets and many of these countries are rich in natural resources," says Curt Lyman, managing director of HighTower Advisors in Chicago. "In the entire history of capitalism, capital has followed cheap labor and inexpensive natural resources."

That has tremendous implications for infrastructure, energy, transportation and home builder plays, Lyman says. (If only Toll Brothers (TOL) could ship all its vacant McMansions to Shanghai. . . .) And it's not exactly a secret in the investing world. But what's sometimes overlooked in all that emerging market growth is the birth of a big new middle class.

That's where the new Thematic Investing Team at Citigroup's (C) Citi Investment Research comes in. This group of nearly 20 economists and analysts issued their first report last week and it's a 32-pager worth reading. The gist is that rapid income growth is pushing large numbers of consumers in developing regions [Citi's emphasis] into the global middle class, even as income growth slows for middle class consumers in developed regions.

The upshot? A big global emerging market consumer opportunity. Indeed, the number of middle income consumers will grow by more than 800 million in the next two decades, according to World Bank projections, with half of those new consumers located in China and India. More broadly, developing countries will account for 93 percent of the global middle class by 2030, according to the World Bank, up from 56 percent in 2000. Since middle income consumers currently represent a $12.5 trillion market (for comparison, U.S GDP is about $14 trillion), you can see the potential goldmine ahead.

Or, in other words, it sounds like someone is going to need a heckuva lot more Happy Meals, iPhones and Snugglies.

Naturally, it's hard to get too excited about investing themes that will take years to play out when we're sill trying to recoup huge losses in our 401(k)s. The Dow Jones Industrial Average ($DJI) is headed in the right direction for now, but it's still off a whopping 30 percent from its October 2007 all-time closing high. Still, this is a trend investors would do well not to ignore.

"Very few investors will think with the same time horizon that will be required to realize the full growth possibilities in these emerging economies," says Adam Harter, an analyst with Financial Enhancement Group of Anderson, Ind. "We expect [China, India and Brazil] to be a piece of our allocation more times than not in the next couple of decades," even if they are not necessarily permanent fixtures.

For exposure to this trend, Financial Enhancement Group likes exchange-traded funds such as FXI, the FTSE/Xinhua China 25 Index fund. Lyman, for his part, painstakingly susses out individual stocks throughout the developing world (Ukraine, anyone?), and so recommends that do-it-yourself investors stick with broad emerging-market ETFs such as PXH, the PowerShares FTSE RAFI Emerging Market fund, or EEM, the iShares MSCI Emerging Markets ETF. That avoids the risks associated with being in any single stock or country, Lyman says.

Citi Research, however, drilled down into consumer stocks to find ideas that should benefit from emerging market consumerism both today and over the long haul. Since too many of the local Chinese and Indian companies lack either a Buy rating from Citi analysts or are too tough to acquire back here at home, we'll just focus on big multinationals with Buy ratings, listed on a major U.S. exchange, that are expected to increase sales in China and India by an average of six percentage points over the next five years:

Dell (DELL). The PC giant is gaining market share in China now and the emergent middle class will focus more on owning so-called quality brands later.

Hewlett-Packard (HPQ). The tech giant gets a thumbs up based partly on its brand and partly because China and India are increasingly buying commoditized PCs and printers.

Honda (HMC). The Japanese car maker is particularly strong in China's prosperous east coast. In India, the company is focused on high-end models and is set to open a second plant there in 2012.

Nokia (NOK). The world's largest handset maker is dominant in both nations, with 45 percent of the Chinese market and 60 percent of the Indian market.

Toyota (TM). The Japanese car maker is struggling a bit in China now, but longer term Toyota should benefit from its strong brand power and hybrid technologies.

Unilever (UL). The consumer products and packaged food giant has been doing business in the region for more than a hundred years, giving Unilever very wide coverage across Asia, with thousands of core distributors supplying its products to millions of retail outlets.

Whether demographics are indeed economics is an argument for another time, but we will leave you with this little fact: There's a baby born every few seconds somewhere in the world, mostly not in the U.S. or Western Europe.

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