Greater spending from the burgeoning emerging market middle class is one of those themes global and emerging market investors have clung to as developed market consumers and governments deleverage. But there’s a growing risk emerging market consumers could start pulling back as commodity pricesfall and higher food priceslighten consumers’ wallets.
Indonesia has been a darling market for investing in this emerging market domestic demand story. Over the past three years, the MSCI Indonesia index gained 15 percent in U.S. dollar terms, making it one of the best emerging Asian markets behind Thailand and the Philippines. Indonesia has already lost some of its shine this year, with the market shedding 0.45 percent.
It may be time to reevaluate the staying power of Indonesia’s domestic consumption story now that commodity prices are easing as China sucks up fewer of Indonesia’s coal, palm oil and oil and gas resources, according to one economist.
Chetan Ahya, Asia-Pacific and Indian economist at Morgan Stanley, is concerned about whether Indonesians can continue shopping. “People are forgetting that it was commodity prices which were one of the key factors supporting domestic demand, and we’re seeing commodity prices declining,” Ahya told CNBC. “So I would be concerned about Indonesia’s domestic demand the most in the region.”
With industrial commodity and oil prices falling, Indonesia’s commodity surplus is declining and the central bank may be called upon to preemptively tighten policy, Ahya said.
“Otherwise, as you saw in the second quarter, the current account deficit came up to 3 percent of gross domestic product,” he warned. “This will result into a problem of currency depreciation and therefore a push-back to the central bank to tighten its monetary policy and cut domestic demand.”
While Indonesia’s domestic demand story is looking a bit more tenuous, Ahya and other regional investors are still focused on consumption as a dominant investment theme across Asia.
“Look at the countries in the region that are creating domestic demand on a sustainable basis,” Ahya said. “Don’t get excited by someone doing another round of monetary easing or fiscal easing. It’s been done for four years. It isn’t creating productive growth in Asia.” He points out that China is improving domestic demand as part of the latest Five-Year Plan and India “will have to eventually start focusing on it.” (Read More: What Slowdown? Indian Consumers Are Still Spending).
Andrew Sullivan, Principal sales trader at Piper Jaffray, also said investors should continue to focus on consumption, not the potential for additional policy stimulus out of China. “There are a lot of good companies out there still that aren’t subject to the overall volatility when the stimulus comes on board,” he said in a CNBC interview.
While he does still see opportunities, stock picking becomes more important from here. “A lot of these have been popular plays for some time and some of them are getting overvalued now that the market has run up,” he cautioned. Sullivan likes “lifestyle” as an investment theme —from companies that provide the daily necessities up to luxury brands. (See: China Slowdown Hitting the High-End?).
Russian consumers also continue to spend. "Russia is seeing double-digit consumer growth," Ian Cheshire, the CEO of UK home improvement retailer Kingfisher , said in a CNBC interviewFriday. "The oil price is helping to keep consumers positive."
But the U.S. drought and a subsequent surge in food prices should give investors pause. David Riedel, founder of the Riedel Research Group, told CNBC, “If you get food and fuel prices rising in tandem, it could derail this concept of the emerging market consumer,” he said.
“In these developing economies, households tend to spend 55 to 60 percent of monthly income on food and fuel, because they don’t have the high health care and housing expenses of the developed world,” he noted.
“Food prices have a huge impact on emerging market consumers potentially in China — which is a huge importer of soybeans and the second largest consumer of corn — and in places like Mexico." (Read More: Massive US Drought Leads to Worst Fears for Corn Crop).
Riedel prefers the companies that will benefit from the drought. He likes Latin American farming company Adecoagro that will benefit from higher prices and fertilizer companies like Potash as farmers look to improve crop yields.
“You want to be cautious on food producers in emerging markets because they will get squeezed by higher input costs,” he warned.