Future Hubs of Africa and Asia

On UN projections between 2015 and 2050, the world population will grow by nearly 2.38 billion people, from 7.35 billion to 9.73 billion. Although this 32% growth is a big increase, it marks a slowdown from the 66% growth rate recorded in the preceding 35 years (1980-2015). Total Fertility Rates (TFRs) have come down all over the world and are expected to continue falling.
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About half of the 2.38 billion increase will take place in sub-Saharan Africa and nearly 40% in Asia. India is the biggest contributor with a net addition of 394 million, followed by Nigeria (216m), Pakistan (120m), DR Congo (118m) and Ethiopia (89m). By 2050, all of these countries will feature in the top 10 populations by size, a list that will include the United States (expected to rank fourth) but not one European country. Outside of Africa and Asia ex-China, regional populations will be growing slowly (the Americas), stagnating (China, Europe), or receding (Japan, Eastern Europe). Read more

A Different Kind of Border Wall

To slow mass migration, stop the illicit capital flight from poor to rich countries.

An asset manager called ____ Capital recently sent out this email seeking referrals:

The US Investor visa program allows one to invest $500,000 U.S. in a government licensed fund for a period of about five years and in around 18 months, a conditional green card is attained for the investor and their immediate family. The investor and their family can live, work and study anywhere in the United States and there are no educational, age or English language requirements.

Most experts report that on September 30th the investment amount will increase from $500k to $1.3m, a significant jump that will price out many potential investors.

There is still time to file before September 30th if you start your process with ____ Capital now.

Others can comment on the practice of selling green cards (and ultimately US citizenships) to wealthy foreigners while millions of other applicants, some of whom would be greater contributors to the United States, continue to wait in line for years. Our concern is one step removed and has to do with the legality of this money. Read more

How Many People Will Live in Africa in 2050 and 2100?

Large declines in fertility will depend on raising female literacy above 80%.

Every few years, the United Nations Population Division releases demographic projections for the entire world and for every country, region and continent. Although the UN’s database is the most used source on demographics, the data is not equally reliable for all countries.

Countries in the developed world conduct regular censuses and produce detailed numbers that are considered reliable. Less developed countries conduct censuses on an irregular basis or are completely unable to conduct them and have instead to rely on demographic sampling. In the poorest countries of the world, most of which are in sub-Saharan Africa, censuses are infrequent or nonexistent and even sampling can be irregular and unreliable. Read more

The Case for Agricultural ETFs: A Conversation with Sal Gilbertie

“It is really important to have ags in your portfolio. Most people have gold and most people have oil. The fact that they don’t have ags is actually quite a mystery.”    Sal Gilbertie, President of Teucrium Funds.


As Sal Gilbertie would have it, CORN is not only the king of agricultural commodities. It is also the ticker symbol for one of Teucrium Funds agricultural ETFs. In addition to CORN, Teucrium offers three other single-commodity ETFs: WEAT, SOYB, CANE, for wheat, soybean and sugar. Each of these ETFs invests in futures and is configured to “mitigate contango and backwardation” and to track the price of its underlying commodity. A fifth ETF, with ticker TAGS, tracks an equally-weighted basket of corn, wheat, soybean and sugar.

I recently had a conversation with Gilbertie who is President of Teucrium. Gilbertie cut his teeth in the 1980s as a commodities trader at Cargill and later at other large institutions. His case for investing in agricultural commodities is three-fold:

  • the long-term: growth in demographic demand in emerging markets.
  • the timeless: diversification away from the S&P 500 and from gold.
  • the short-term: agricultural commodities are now significantly undervalued relative to gold.

1- Long-term Demand and Supply

Demand for agricultural commodities is expected to rise steadily in the decades ahead due to 1) the growth of the global population currently from 7 billion people to over 9 billion by 2050 and 2) the rise in living standards and concomitant improvement in diets in emerging markets.

The table below shows future population estimates per the United Nations’ medium variant estimates. It should be noted that this medium variant assumes a big decline in total fertility rates (TFRs, number of children per woman) in India and Sub-Saharan Africa. In the event that TFRs do not decline as fast as expected, the population growth in these countries would be even greater.

Asia and Sub-Saharan Africa will show the biggest jump in population and in demand for basic food stuffs. Note in the table that Sub-Saharan Africa is forecast to contribute half the population growth between today and 2050, and as much as 81% of the growth between today and 2100.

Screen Shot 2015-02-20 at 5.53.58 AM

It is not difficult to conclude from these figures therefore that Sub-Saharan Africa will require more than a doubling of food supplies in the next 35 years, a significant challenge at a time when it is still trying to eliminate hunger in many countries.

Of course, supply is also growing but it is generally more volatile than demand due to periodic crop failures (from floods, droughts etc.) in one or another region of the world. Supply is also constrained by two factors: lower yields from farms in emerging markets and poor infrastructure in the regions of the world which have the largest unused acreages of arable land.

In 2012, the African Union Commission (AUC), the United Nations’ Food and Agriculture Organization (FAO) and the Brazil-based Lula Institute joined forces to “eradicate hunger” in Africa. At the time, the Chairperson of the AUC stated the following [my emphasis]:

“Food security is one of the key priorities of the African Union. Africa has the potential to increase its agricultural production given that almost 60 percent of the arable land in the continent is still not utilized. This enormous potential can make a real difference to improve our agricultural production and food security. It is time to move beyond subsistence agricultural production and consider ways of eventually embarking on agro-industrial production.”

More generally, looking at the global picture, Sub-Saharan Africa is believed to have the largest reserves of untapped arable land. As promising as this may be, massive investments in technology, infrastructure and logistics will be needed before new farm land can yield significant amounts of grain that can be delivered to consumers.

With regards to agricultural yields, an FAO report released in 2002 stated:

“Global cereal yields grew rapidly between 1961 and 1999, averaging 2.1 percent a year. Thanks to the green revolution, they grew even faster in developing countries, at an average rate of 2.5 percent a year. The fastest growth rates were achieved for wheat, rice and maize which, as the world’s most important food staples, have been the major focus of international breeding efforts. Yields of the major cash crops, soybean and cotton, also grew rapidly.”

For example, wheat yields in developing countries have nearly tripled from 1,000 kilograms per hectare in 1968 to over 2,600 now.

To sum up, supply will keep up with demand but only if yields improve at existing farms and if new infrastructure is put in place to service new arable land.

2- Timeless Diversification

Agricultural commodities are less correlated to the stock market than gold and should therefore be considered for diversification at any time. In recent decades, gold has drawn tens of billions in portfolio investments mainly because it was seen as a hedge against possible dislocation in financial markets.

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Gold delivered on its promise as an effective diversification asset in 2008-2011, outperforming stock markets by a wide margin during the financial crisis and its aftermath. Although it has retreated from its 2011 highs in recent years, gold is still a significant outperformer of all leading stock indices in the decade and a half since it hit bottom in 1999. See chart above.

Of course, gold grossly underperformed stocks in the 1990s, but the subsequent decade proved that there can be prolonged periods of time when it beats the popular indices by a very significant margin, notwithstanding comments by some market participants who deride it as barbaric or uncivilized. The pragmatic reality is that, barbaric as it may be, gold sometimes outperforms stocks for ten or fifteen years.

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Still, if we have shown that diversification into commodities is desirable, the chart above from Teucrium’s web page argues that agricultural commodities are even better diversifiers than gold because they have a lower historical correlation with the S&P 500 than gold does. Through the 20-year period 1995-2014, sugar, corn, wheat and soybean have all had a lower correlation to the S&P 500 than has gold.

3- Short-term Valuation

The ratio of gold to corn was in September 2014 at its highest level since gold started trading freely 38 years ago. It stands today at nearly twice its long-term average. Gilbertie says that, on average since 1976, an ounce of gold has purchased 165 bushels of corn. Last September, an ounce of gold could buy 377 bushels and today it can buy around 300 bushels, still nearly twice the long-term average.

The ratios of gold to the other grain commodities and to sugar tell a similar story.

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Thank you for reading. My conversation with Gilbertie includes more original insights about the mechanics of trading futures and ETFs and about the supply and demand prospects for agricultural commodities.

You can listen to the full podcast here:

Disclosure: The author has no contractual agreement with Teucrium and receives no compensation from Teucrium. As of the date of this posting and for at least the following 72 hours, the author has no investments in the Teucrium Funds.

Disclaimer: This article represents the author’s best faith efforts at presenting true facts. Nonetheless, despite the author’s best diligence, the article may include unintentional errors. Do your own work, read more research and draw your own conclusions before you decide to trade.

Coach: Ripe for Takeover?

“International sales decreased slightly…”

That’s a sentence you do not want to see when you are looking at a company which is viewed by many as a significant player in the booming global luxury goods sector. And yet, there it is, in Coach’s first quarter report released a few days ago. To be fair, the slight decrease in sales was due to rare and large currency fluctuations. The dollar rose by 27% against the Yen in the last year, an extreme move not often seen with major currencies. On a constant currency basis, international sales rose 9% in the quarter, which is reasonable but not a barn burner. A bright spot was China where sales boomed 35%. So there was some good news behind the headline.

Despite the Q1 disappointment, Coach’s net income and free cash flow margins remain strong. Its main problem is not profitability but the fact that North America contributes 67% of total revenues and has essentially gone ex-growth.

If you put Coach in the bucket of luxury goods companies (which are mostly European), it is clear that Coach is badly underperforming. Sector peers LVMH, Burberry, Richemont and others have zoomed ahead with sales, profits and stock prices not far from their all time highs. The main reasons for their greater success have been their more aggressive expansion into Asia and stronger brand management.

But if you put Coach in a more general bucket of consumer and apparel companies, then it is doing better than some and worse than others. The issue however is that the company’s future will be largely determined by which bucket it puts itself in. As a luxury goods company, it can maintain some pricing power and it will preserve or raise its margins and market value. It could also merge with or be acquired by one of the Europeans. But as a general consumer company, its brand will get tarnished. Its margins will continue to erode and so will its valuation.

Coach’s problems can therefore be summed as follows:

–          An insufficient geographic footprint outside the US.

–          A large North American presence which has stalled.

–          A brand that is in danger of falling out of the “luxury” sector.

The store opening program can be accelerated overseas if there is sufficient confidence that the luxury boom will continue. Coach has a strong balance sheet and is generating positive free cash flow. In theory, therefore, it has important untapped reserves which it can deploy to open stores at an accelerated rate.

North America will be more difficult to fix, given intense competition from the likes of Michael Kors and Kate Spade. Here, design appeal and brand management are key to an eventual recovery. Coach faces the risk of what the French call “Cardinisation”, the fate met by the Pierre Cardin brand when it became so ubiquitous that it lost its luxury stamp.

In this sense, the fact that 60% of Coach’s North American sales occur in factory outlets is positively troubling. Sales at these outlets come at better margins because of lower costs and higher volumes but they damage the brand and could reclassify it outside of the luxury sector. And that could be the beginning of a death spiral for pricing.

A quicker fix would be to sell the company to another luxury goods firm. An acquirer who already has a large presence in Asia and Europe could quickly boost Coach’s overseas revenues and lower its costs. Conversely, Coach’s large US presence could be of benefit to an acquirer looking to grow its own American sales. One problem is that a buyer may initially look to strengthen the brand by closing some factory outlets. This could reduce North American volumes in the near term, a consideration which may depress any proposed takeover premium.

So is this a good price to buy the stock?

Yes, because international sales growth will soon return and for the possibility of a takeover.

No, because branding issues and North America are unlikely to be resolved in the next quarter.

All in, it is a buy for speculative portfolios. More conservative investors should look to buy at a lower price if the company takes steps to avoid further erosion of its margins and to move its brand upscale.

Note: Last year, I wrote more generally about prospects for the luxury goods sector.

Disclaimer: The views expressed here are not intended to encourage the reader to trade, buy or sell Coach stock or any other security. The reader is responsible for any loss he may incur in such trading.

Europe: Was (Is) It Worth The Trouble?

No for indexers. Yes for macro trend investors. Maybe (but probably not) for bottom-up stock pickers.

European stocks face a unique situation, which is that, outside of the rolling debt crises from Ireland to Iceland to Greece to Spain, their performance has been, and will continue to be, driven by macro factors emanating from outside the European Union.  This is mainly because Europe itself has the worst demographics of any region of the world with declining or stagnant populations in several countries and rising dependency ratios (dependents per worker) in all countries (see tables or, for more on demographics, see Demographic Megatrends of the 21st Century).  Therefore, except for the cyclical recovery which may or may not show up this year or next, the longer-term prognosis for domestic demand growth is far from encouraging for a large majority of European companies.

UN   Estimate Total Fertility Ratio Population (millions)
  2010 2030 2050 2100 2010 2030 2050 2100
 France 1.99 2.04 2.06 2.09 63 68 72 80
 Germany 1.46 1.74 1.9 2.05 82 79 75 70
 Italy 1.48 1.75 1.91 2.05 61 61 59 56
 UK 1.87 1.97 2.03 2.08 62 69 73 76
 Europe  1.59 1.82 1.93 2.06 738 741 719 675

These estimates are from the United Nations medium variant. Note how the dependency ratio declined for the past four decades and is now expected to rise in the next four.

 Dependency Ratio 
1950 1970 1990 2000 2010 2015 2020 2030 2050
 Europe 52 56 50 48 46 50 54 61 75
 USA 54 62 52 51 50 53 56 64 67

It is fortunate therefore that Europe has some tremendous companies, large and small, which are global leaders in their sectors and which can find growth outside of Europe’s borders.  A large number of these companies have had a very strong performance in recent years thanks to slow growth in the US and fast growth in emerging markets, in particular China. Good examples are iconic automaker BMW, luxury goods powerhouse LVMH, chemical giant BASF, retailer Hennes & Mauritz and many many others.

(Note: stock tickers not shown in the text are shown in the tables, using the Bloomberg convention)

Some of these winners have been smaller companies. Consider for example the Finnish tire company Nokian Tyres (NRE1V FH) spun off from Nokia (NOK1V FH) in 1995. Although Nokia has for years been followed obsessively by investors, it is Nokian Tyres which has outperformed Nokia proper by a stunning margin over the past seventeen years (except for 1998-2002 and 2008-09) logging in a nosebleed gain of nearly 4900% since the spinoff vs. Nokia’s decidedly paltry cumulative 11.3% (excluding dividends). Even if you exclude Nokia’s decline after 2007, the outperformance would still be very large. (Note to Apple AAPL watchers: it may be better to look elsewhere).

In the 1990s, there was much talk of the benefits to investors from geographic diversification. Academic research made a case that greater returns could be achieved with less volatility, a case which was then amplified in the financial media by large mutual fund companies. It is not within my scope to rebut this case from a theoretical perspective. For the next section however, I looked at the numbers empirically and they show that a multi-country European stock index would have underperformed the US or other global markets in the past ten and twenty years. In many periods, this underperformance was not accompanied by a correspondingly lower volatility. In fact, the volatility of European markets in 1996-98 and 2005-08 seems to have been higher. A European indexed fund or ETF (VGK, IEV), to put it plainly, was simply not worth it.

Because the vast majority of mutual funds underperform their benchmark index, you could also say that European mutual funds were not worth it.  In the event of a large deviation between a foreign stock fund and its benchmark, such deviation could usually be explained by currency moves rather than the fund managers’ skill at selecting a portfolio of superior stocks.  This was certainly the case in the 2003-07 bull market when US dollar weakness greatly helped all funds which were not fully currency-hedged. Here the financial media usually gave all the credit to the fund managers’ superior stock selection (often alleged) and not enough attention to the currency moves (always real).


European stock indices usually move in step with the US market.  This is not true in every single year but it is true in most years and on a multi-year basis if not in magnitude, certainly in direction. Going back ten years, the European markets moved roughly in line with the S&P 500 except for 2005 when the European index outperformed by a wide margin, and 2010-2011 when the S&P 500 outperformed for two years in a row.

As things stood last December 31st, Europe had returned 38% in a decade and the US 62%. Much of this underperformance can be attributed to the strengthening of the Euro which nearly doubled against the US dollar in 2001-2008. A strong Euro/weak dollar is detrimental to European indices which are heavily weighted with exporters. A dollar-based investor in Europe who did not hedge out the currency would have benefited from the stronger Euro and would have recorded, in the decade ending on December 31st 2012, a gain of 67% from European indices, marginally better than the S&P 500.  On a twenty year basis, the European index returned 162% for a currency-hedged investor and 196% for an unhedged investor, in both cases less than the S&P 500 which returned 227%. (These returns and the ones shown in the table do not include dividends).

Nonetheless, the overall European index (I use MSCI Europe) masks important differences between countries.  Although the EU has gone a long way to reduce these differences, they continue to be relevant because regulation, taxation, work ethic and basic business practices remain largely country-specific. It is trite to say that Germany is the uncontested leader in Europe, but it has emerged by now in early 2013 as the primary beneficiary of the Euro project.  I made a case here that Germany should in a strange way be thankful for Greece, because it is the presence of Greece (and Italy and Portugal) within the Euro sphere which has kept the Euro at a level that is weak enough to help German exports and to sustain the German economy on a growth path.  Without the Euro, the Deutsche Mark would have been stronger against other leading currencies and Germany’s economy would have probably fared worse than it did.

Twilight or sunrise?
Twilight or sunrise?

When you look at country indices going back two decades, a few things stand out quickly. First, the US, UK and Germany have recovered nearly all their losses of 2008-09, whereas France, Spain and Italy have not.  Second, Germany has outperformed the US by a wide margin in the past ten years and in the past twenty years. Spain has also outperformed the US in the past twenty years but that is mainly due to the first decade 1993-2002 when the Spanish stock market, along with Italy, was a huge beneficiary of the convergence trade preceding the adoption of the Euro.  The UK has lagged the US and Germany but has done better than France in the more recent decade.  All in, of the large markets, Germany stands out as a big winner, Spain a winner only in the first decade, Italy as a big laggard, and France and the UK somewhere in between.

The smaller Nordic markets have done exceedingly well over the past two decades.  Norway was greatly helped by its exposure to oil and oil services in the past decade.  Sweden and Denmark did very well in both decades thanks to stellar performers Hennes & Mauritz, Atlas Copco, Novo Nordisk (NOVOB DC) and TopDanmark (TOP DC). Finland’s index benefited from Nokia’s large market cap weighting in the 1990s and suffered from it in the last five years.  Ex-Nokia, the Finnish index would in fact show an impressive performance in recent years. On the two decades 1993-2002, Finland is still the best European performer by far. Like Germany, it has many world-class exporters.

 1993-02  2003-12 1993-12 2003-07 2008-12
 USA  S&P 500 101.9% 62.1% 227.3% 66.9% -2.9%
 Europe Local  MSCI 89.8% 38.2% 162.3% 85.9% -25.7%
 Europe USD  MSCI USD 77.9% 66.7% 196.4% 144.5% -31.8%
 UK  FTSE 100 38.4% 49.7% 107.2% 63.9% -8.7%
 Germany  DAX 30 87.2% 163.2% 392.7% 178.9% -5.6%
 France  CAC 40 64.9% 18.8% 96.0% 83.2% -35.1%
 Spain  IBEX 157.5% 35.3% 248.4% 151.5% -46.2%
 Italy  FTSE MIB 138.9% -30.8% 65.3% 62.8% -57.8%
 Switzerland  SMI 119.8% 47.3% 223.8% 83.2% -19.6%
 Netherlands  AEX 148.8% 6.2% 164.2% 59.8% -33.6%
 Sweden  OMX 174.6% 124.0% 515.0% 119.3% 2.2%
 Norway  OBX 320.0% 332.0% -2.8%
 Denmark  OMX 166.8% 148.7% 563.5% 132.7% 6.9%
 Finland  OMX 596.7% 0.5% 599.8% 100.8% -50.0%
 Brazil  Bovespa 166089.0% 440.9% 898832.0% 467.0% -4.6%
 Brazil USD 111.3% 836.5% 1879.1% 1030.2% -17.1%
 China  Shanghai 74.0% 67.1% 190.8% 287.6% -56.9%
 Hong Kong  Hang Seng 69.1% 143.1% 311.0% 198.4% -18.5%
 Japan  Nikkei 225 -49.3% 21.2% -38.6% 78.4% -32.1%

Among emerging markets, Brazil was a very strong performer.  The Brazilian Real’s devaluation against the US dollar in the 1990s explains much of this performance.  But Brazil has been one of the best global performers even on a dollar basis.  China has had a respectable performance, but perhaps one more muted than many would have guessed from the steady barrage of headlines about the rise of the Chinese superpower. And Japan as we know has been a dismal place to be an indexed investor, except for brief spurts in the mid-90s and in 2003-07.

Net net Europe has underperformed the US on both a one decade and a two decade basis whereas several emerging markets have performed in line or much better than the S&P 500.  All of this may be discouraging if a person worries about the indices too long. But for those who ignore the indices, Europe offers outstanding opportunities.


After the closet indexers have left the room (or clicked away from this page), we can now talk about two incontestable reasons to invest in Europe: 1) an early warning system and 2) a leveraged play on other markets or trends.

Europe as an early warning system

The first reason is that early signs of an impending crisis often emerge in Europe before they do in the US. This is true not because Europeans are more prescient than Americans, but because their stock market is more fragmented into individual countries.  It would be the same here if each state of the United States had its own stock market.  In that case, we might have , for example in 2007, picked up on signs of distress in the subprime market through the Arizona, Nevada or Florida stock markets several months before they became visible in national indices temporarily held up by other, more buoyant sectors.

If a manager has some holdings in Europe, he is likely to pick up on signs of trouble before his competitors do and long before they appear in the major headlines. This was certainly true in 1997 and 1998 when European banks with large exposures to faltering Asian markets and to Russia telegraphed signals to the bullish markets in the late spring and early summer that all was not well. And it was also true in 2000, when stodgy companies like Alcatel (ALU FP) and the old state-owned telecom operators were trading at very inflated multiples normally reserved for hot new companies coming out of California.

This ‘Europe as an early warning system’ delivered again in the crash of 2008, in particular for people who were paying attention to Ireland. The S&P 500 recorded a small gain in 2007 but Ireland which had wholeheartedly embraced the housing bubble saw its index fall by 27%. Italy too was down in that same year, but by a less alarming 7%.

When the US subprime crisis erupted in 2007 and 2008, there was in Europe widespread belief and barely concealed schadenfreude that the Americans, already out of favor on the continent because of the Iraq war, were getting their comeuppance and that Europe, reinforced by a growing Euro sphere and a billion eager Chinese customers, could now promote its economic success as a new model for other countries. As we know, reality came back unsparingly when all Euro markets crashed in late 2008.

In 2011-12, the US market was to some degree driven by the daily news flow from Greece, Spain, Italy and other parts of Europe. For a while, exploding sovereign yield spreads threatened to throw in reverse the conversion trade of the late 1990s and to tear the Eurozone apart. And now Europe has combined bailouts and austerity and the US has combined bailouts and stimulus, with the net result that Europe is in recession and the US is growing modestly. In the coming years, it will still be a good idea for US investors to keep an eye on Europe, even if its importance has diminished in the global sales mix of American companies because of emerging markets.

I recognize that getting an early distress warning is by itself an insufficient reason to draw investors into Europe.  Insurance is a good idea but no one wants to overpay for it or feel that it has become a distraction. A larger and more positive reason to invest in European stocks is that they offer an excellent way to get exposure to other markets.

Europe as a leveraged play on other markets

Investing in Europe to get exposure to other, non-European, markets and trends can be exceptionally rewarding.  Most of the news that may push many large and midsize stocks higher or lower comes from outside of the European continent, chiefly from the US and China.

Exposure to the US dollar and US economy

Until China became a major source of export demand for European goods, the US economy was the most important driver of earnings growth for a large number of European firms. For this reason, the exchange rate of the dollar vs. European currencies was an important factor in the earnings of these companies. European stocks were a leveraged play on the US dollar. If the dollar moved 5%, some stocks would move 10 or 20%. It is true that you could instead invest directly in the currency markets but stocks gave you more leverage and also gave you the possibility of gaining from periodic efforts to create shareholder value. In the 1990s, for example, you had a wave of restructurings, followed by the tech boom. In the 2000s, you had the commodity boom and the rise of emerging markets.

Exposure to the Chinese economy and other emerging markets

Europe’s relationship to the US dollar and US economy still exists but it has been diluted by the rise of another very large client, the Asia-Pacific region. For a majority of large and midcap European companies, the Asia-Pacific region has replaced the US as the main source of sales growth. China and Japan are obviously the two main poles of demand, with China showing by far the fastest growth rate in the sales mix of European firms. One of the best ways to get exposure to the growing Chinese economy has been through a portfolio of European exporters which are global leaders in their industries.  In fact, such a portfolio would have handily outperformed the stock markets of China and Hong Kong in recent years. This may not be intuitive but investing in European exporters has been one of the best ways to invest in Chinese growth.

Nowhere is this more true than in luxury goods and prestige brand companies which have seen a growing percentage of their revenues coming from the Asia-Pacific Region. Luxury goods companies Hermès, Richemont and Swatch now have about 50% of their sales in that region.

 Luxury & Spirits     Market Cap   AsiaPac % 
     Billions USD   2011 Sales 
 Burberry  BRBY LN           9.49 34%
 Campari  CPR IM           4.44
 Diageo  DGE LN         74.33 10%
 Ferragamo  SFER IM           4.44 34%
 Heineken  HEIA NA         42.50
 Hermes  RMS FP         35.91 46%
 LVMH  MC FP         91.18 27%
 Pernod Ricard  RI FP         33.49 39%
 PPR  PP FP         27.16 24%
 Remy Cointreau  RCO FP           6.46 39%
 Richemont  CFR VX         46.74 51%
 SAB Miller  SAB LN         79.62
 Swatch Group  UHR VX         29.85 54%

European companies are by far the world leaders in luxury goods, and the French among them own some of the strongest brands. LVMH is the largest luxury goods company in the world, with an extensive portfolio of brands, including Louis Vuitton, Bulgari, Dom Perignon and Tag Heuer (see full list of LVMH brands here).  France also has Hermès and spirits companies Pernod Ricard and Remy Cointreau. Switzerland has the Swatch Group, the parent of Blancpain, Breguet, Omega, Glasshutte and, as of this year, Harry Winston (see Swatch Group brands here). Also in Switzerland is Richemont, the parent of Cartier, Montblanc and Vacheron Constantin (see Richemont brands here). Italy has Salvatore Ferragamo, spirits company Davide Campari, eyeglass leader Luxottica (LUX IM) and leather company Tod’s (TOD IM). Germany has automotive luxury with BMW, Porsche, Audi and Mercedes.  Porsche and Audi are part of Volkswagen, and Mercedes is part of Daimler (DAI GY). All of these countries also have many more luxury goods companies which are not publicly listed. I have also written about the luxury goods market in BMW, Louis Vuitton, Swatch: Can the Boom Continue?

The US is active in many of these sectors but has few dominant companies.  Coach (COH) and Tiffany (TIF) offer excellent products but cannot match the pricing power, brand supremacy, geographic footprint and cash flows of Hermès, LVMH or Swatch. US firms have also enjoyed better growth in their home market and have not felt the need to expand into the Asia-Pacific region as aggressively as the Europeans have.

Another sector which has benefited from the growth of emerging markets is industrials.  Here too, Europe has some global leaders in autos, chemicals, machinery, industrial gases, aircraft and heavy trucks. In the first nine months of 2012, for the first time ever, BMW sold more cars in China than it did in the United States.  BMW also owns Rolls Royce cars and the Mini brand. And Volkswagen in 2012 delivered nearly four times as many cars in the Asia-Pacific region as it did in North America. All three of BMW, Volkswagen and Daimler are present in both the luxury sector and the industrials sector: BMW through its own brand, Rolls Royce and Mini; Volkswagen through its own brand, Porsche, Bentley and Audi and its ownership stakes in Scania (SCVB SS, 46% of capital) and in MAN (75%); and Daimler through its Mercedes cars and trucks and Freightliner trucks.

Industrials   Market Cap AsiaPac %
    Billions USD 2011 Sales
Air Liquide AI FP          38.73 22%
Assa Abloy ASSAB SS          14.86 9%
Atlas Copco ATCOB SS          34.79 28%
BASF BAS GY          89.56 20%
Bayer BAYN GY          79.07 21%
BMW BMW GY          62.00 17%
Duerr DUE GY            1.75 39%
EADS EAD FP          39.13 29%
Henkel HEN GY          34.96 15%
KUKA KU2 GY            1.51 24%
MAN MAN GY          17.48
Rolls Royce RR/ LN          28.61
Volkswagen VOW GY        108.79 14%
Zodiac ZC FP            6.46

Because of its Airbus division which competes with Boeing, EADS may be of particular interest to US readers. Last year, I wrote about the epic battle between the two aircraft manufacturers in Boeing vs. Airbus: Orders and Profits. Since then, EADS has undergone some important changes in its shareholding structure. Its free float which is now 54% is expected to rise above 70% after large legacy shareholders reduce their stakes. Management has expressed a new commitment to transform the company from a conglomerate of state-owned or state-sponsored businesses into a more ‘normal’ company which is more responsive to shareholders.

Finally, Europe has some outstanding companies in the mass-market consumer and retail sector which expect to grow in emerging markets as well as in the United States.  Notable among them are Hennes & Mauritz and Inditex, the parents of retailers H&M and Zara, and cosmetics giant L’Oreal.

 Consumer/Retail     Market Cap   AsiaPac % 
     Billions USD   2011 Sales 
 Adidas  ADS GY           19.63 16%
 BAT  BATS LN         100.55 28%
 Beiersdorf  BEI GY           22.32
 Bic  BB FP             5.78
 Hennes & Mauritz  HMB SS           60.76
 Hugo Boss  BOSS GY             8.47
 Inditex  ITX SM           88.35
 L’Oreal  OR FP           91.98
 Nestle  NESN VX         226.60
 Unilever  UNA NA         118.07 41%

What Europe does not have

Outside of indexing and macro driven investing, what about simple bottom-up investing?  Ideally, we would like to invest in names which are insulated from the big macro questions of US and China growth.  However, it is difficult to imagine many large or midsized European stocks doing well in the event of a Chinese slowdown and US recession.  Under this scenario, it would be best to find a handful of smaller names with their own domestic growth dynamic.

Yet, if this seems like a desirable strategy, the US market is more fertile ground to find such small companies for two reasons: 1) the US has more new companies which go public and 2) these companies can grow domestically for longer because the size of the domestic market is many times larger. A good example is Whole Foods (WFM) which was still a small cap name in 2000 (and again briefly in late 2008). It now has over 300 stores in the United States (and 15 in Canada and the UK) and added ten new stores in the last quarter, eight of which were in the US. A similar European company would have hit the wall in its home market at a much earlier stage.  Outside of the large trends described above, there is, in my view, little reason for a US-based investor to put money in a small European company unless it is really a very unique and irresistible story with no US equivalent.

The clear Nordic air
The clear Nordic air

You might think that Nokian Tyres fits that profile. But even here, much of the company’s growth is directly linked to demand from Russia, which is itself tied to the rise in energy prices and ultimately, to the growth of the Chinese economy.  Should that economy slow down, the price of oil would decline which would dampen Russian demand for all sorts of goods, including tires.  Because European companies have a smaller domestic market than their US counterparts, it is more difficult to find good secular growth stories which are not dependent on the global growth picture.

If we redefine a company’s domestic market as the whole of Europe instead of just its home country, we find a handful of steady growth names. A notable pan-European success is the Swedish retailer Hennes & Mauritz which has 406 H&M stores in Germany, 226 in the UK, 182 in France, 177 in Sweden and hundreds of others elsewhere. It also has 269 in the US (from none in 1999) and 111 in China. H&M is among a handful of retailers that have gained market share in several markets (another is Inditex’s Zara). Today, the company’s growth is very much tied to globalization given that its cash flow (and ability to invest) is derived from a very high gross margin, the result of sourcing its products from 700 independent suppliers mostly in Asia. Hennes’ gross margin has expanded from 44.6% in 1998-99 to a blistering 59.5% in 2012 (it was over 60% in 2010-11). As a comparison, Gap’s gross margin in 2011 was 36.2%, down from 45.3% in 1999.

Other interesting growth companies include food caterers Compass (CPG LN) and Sodexho (SW FP), eye lens maker Essilor (EF FP), lock manufacturer Assa Abloy (ASSAB SS), diabetes care leader Novo Nordisk (NOVOB DC), health product suppliers Coloplast (COLOB DC) and Getinge (GETIB SS) and oil services companies Technip (TEC FP), TGS Nopec (TGS NO) and Seadrill (SDRL NO).  Yet they all seem in varying degrees to have grown to their current size because of demand from outside Europe. I maintain that the odds of finding several small or mid cap stocks which will grow year after year from domestic demand alone are significantly lower than in the US.

Europe also does not have a large investable technology sector. Among larger companies, there are SAP (SAP GY) and ASML (ASML NA). Every country has a smattering of smaller companies which operate in services or in manufacturing niches.  What some Europeans call technology tends to be larger scale and sometimes state-sponsored, an R&D effort which may very well be on the cutting edge but which has more to do with machinery and engineering than with computers, data processing or the internet. This includes high speed trains and nuclear plants where the French are leaders. Perhaps there will be another new technology where European companies will take a lead, but if the history of mobile phones is an indication, this leadership will probably be short-lived.

The conclusion is two-fold:  1) the main reason to invest in Europe has in recent years been non-European demand for some superior products and 2) Europe has been the first place to see early signs of an emerging crisis. One has to approach European investing with a macro perspective developed elsewhere, by analyzing demand in the US and China, and then choose the global leaders which are best leveraged to that macro perspective. Obviously, this could work in reverse with a vengeance.  Any evidence of a prolonged Chinese slowdown would tumble some luxury goods and industrial stocks by 20%, 30% or more.

Because Europe is now in recession, a recovery would certainly result in a cyclical upturn in earnings for many companies. Value investors today should be sifting through the long list of beaten down names, among them the long suffering French volume auto producers Peugeot (UG FP) and Renault (RNO FP). But European demographics are poor and cannot contribute a sustained source of demand.  This means that, beyond the cyclical recovery, the longer term growth driver for most European equities will still have to come from outside Europe.