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VERSACE: Contemplating the global new middle class

- - Thursday, July 14, 2011

ANALYSIS/OPINION:

Looking back at a chart of the Standard & Poor's 500 this week, I see a market that is reeling from a number of factors and data points. Some conflict with others, and some are good only in so far as they are not as bad as they have been. All in all, not very reassuring for those concerned about investments amid European debt woes, the game of chicken under way with our own debt-ceiling and deficit-reduction talks, and rating agencies that are all to ready to make up for past mistakes and oversights. On Wednesday, Moody's Investors Service warned that the U.S. may lose its top-notch credit rating if lawmakers fail to increase the country's legal borrowing limit and the government misses debt payments.

While the above is bad enough, what I find even more troubling is the reversal of several recent favorable trends that remind me we are still in a one step forward, one step back economy here in the U.S. These reversals include the resumption of layoffs and the rebound in prices for gas and other commodities. This week alone, the investment community is rumbling with talk of Cisco laying off up to 10,000 employees, roughly 14 percent of its work force, not to mention the findings last week from Challenger Grey & Christmas. Add to that the news that Connecticut has started sending layoff notices to its public employees after the failure to approve Gov. Dannel P. Malloy's proposal to save $1.6 billion in concessions and savings, and it seems the dip in weekly initial jobless claims reported Thursday may be short-lived.

Is it a surprise then that gold prices are near record highs and, according to Gallup, Americans' satisfaction with the way things are going in the country fell to a two-year low in July? For those keeping count, Gallup reports that the satisfaction level fell to 16 percent in July, the lowest reading since 15 percent in February 2009, which marked President Obama's first full month in office. Other Gallup data out this week show Americans' economic confidence remains near its 2011 lows and shows little to no improvement from year-ago levels.

Yet as we march headlong into corporate earnings, there have been some positive surprises, and, yes, they have been from companies that delivered better-than-expected results because of strong demand, not just cost-cutting and the benefit of prior headcount reductions. Case in point: Yum! Brands, which owns KFC, Taco Bell and Pizza Hut. Despite the drop in its domestic business during the second quarter, Yum! went on to deliver better-than-expected earnings for the quarter and raised its 2011 earnings forecast. The reason? China, the world's fastest-growing major economy, is the biggest profit driver for Yum! accounting for roughly 40 percent of its overall profit. While sales in the domestic market were down, sales at the more than 4,000 restaurants Yum! has in China were up 18 percent in the quarter.

As I see it, Yum! benefited from what I call "the rise of the new middle class," which refers to the improving socioeconomic landscape and better lifestyles in a number of countries, including China, India and other emerging economies. As disposable incomes improve and quality of life rises, this new middle class spurs demand for goods and services that previously was not there: clothing and other textiles, cosmetics and other sundries, food and energy, and so on. According to the World Bank, developing countries were home to 56 percent of the global middle class in 2000, but by 2030, that is expected to rise to 93 percent. Sounds like a long-term trend to me.

While keeping one eye on the domestic and European debt and deficit headlines, I would suggest investors use the other to look into companies, including Yum!, Avon Products, Tupperware Brands Corp. and others that derive a meaningful percentage of profits from those new middle-class economies.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.