BRICs Priced for Economic MeltdownMichael Patterson
The biggest emerging markets are contributing more than ever to the global economy as their proportion of the world stock market shrinks, leaving investors with the widest valuation gap in seven years.
Brazil, Russia, India and China, known as the BRICs, will comprise 20 percent of the world economy this year after growing more than four-fold in the past decade, International Monetary Fund data show. At the same time, their combined stock-market value has dropped to a three-year low of 16 percent of the total invested in equities, according to data compiled by Bloomberg.
To Jim O’Neill, the chairman of Goldman Sachs Asset Management who coined the term BRIC in a 2001 research report, the 4 percentage point difference makes stocks in these markets irresistible. The last time the gap was this wide, in 2005, the MSCI BRIC Index jumped 53 percent in 12 months, more than double the gain in the MSCI All-Country World Index.
“Unless we are seeing a major collapse of those economies, it’s a huge opportunity for investors,” O’Neill, who helps oversee $824 billion, said in a June 28 phone interview. The BRIC stock markets may double by 2020 as their share of world gross domestic product increases to about 27 percent, he said.
Combined GDP in the BRICs will rise to more than $14 trillion this year from $2.8 trillion in 2002, according to the IMF. Their equity value, which includes locally-traded shares and companies based in the BRIC nations with primary listings abroad, has dropped to $7.6 trillion from $9.5 trillion a year ago, when they made up 18 percent of the global total, according to data compiled by Bloomberg.
The MSCI BRIC index advanced 1.8 percent to 269.58 at 10:56 a.m. in New York. The MSCI All-Country gauge rose 0.8 percent.
Petroleo Brasileiro SA, Brazil’s state-controlled oil company, fell to the world’s 39th-largest company by value from the 10th-biggest in July 2011. China Construction Bank Corp.’s rank dropped to 20 from 12 while OAO Rosneft, Russia’s largest oil producer, sank to 106 from 70. ICICI Bank Ltd., India’s second-biggest lender, has lost 17 percent during the past year, compared with an average gain of 9 percent for global peers.
The retreat has pared what was a 180 percent increase in the MSCI BRIC index since October 2008 and reflects concern that economic growth is slowing, according to John-Paul Smith, an emerging-market strategist at Deutsche Bank AG in London. Mutual funds that invest in BRIC equities, which recorded about $70 billion of inflows in the past decade, have posted 16 straight weeks of withdrawals, losing a net $5.3 billion, EPFR Global data show.
While the BRIC economies expanded by 4.8 percent on average during the first quarter, more than double the pace in the U.S., their growth decelerated from 6.8 percent a year earlier.
Falling stock markets suggest the slowdown will worsen because share prices are a leading indicator of economic growth and corporate profits, said Michael Shaoul, the chairman of Marketfield Asset Management in New York. The $2 billion Marketfield Fund has topped 99 percent of its peers this year in part because of bets that emerging-market shares will retreat.
“Equity markets have started to anticipate much more difficult economic times in these countries,” Shaoul said in a June 28 phone interview from New York. “The balance of risks is to the downside.”
Brazilian consumer defaults increased to a 30-month high in May, while prices for Russia’s oil exports have dropped about 10 percent this year. In India, the central bank unexpectedly left interest rates unchanged last month after inflation accelerated. A gauge of Chinese manufacturing compiled by the government fell to a seven-month low in June.
BRIC stocks will trail shares of developed markets as many state-owned companies put the interests of their governments ahead of shareholders, Smith wrote in a June 26 research report.
Petrobras, as the Brazilian oil producer is known, tumbled 9 percent on June 25 to the lowest level since November 2008 after securing a smaller fuel price increase than investors had anticipated. The Rio de Janeiro-based company, whose market capitalization has dropped to $122 billion from $214 billion a year ago, sells fuel at below-market prices to help the government contain inflation in Brazil.
India may lose its investment-grade credit rating as Prime Minister Manmohan Singh’s administration struggles to curb a record trade deficit, a budget shortfall that exceeded targets and fighting within the ruling coalition, Standard & Poor’s and Fitch Ratings said last month.
The BSE India Sensitive Index has declined 7.3 percent during the past year and trades for 15 times earnings, down from a peak of 26 times in 2009. ICICI Bank, based in Mumbai, is valued at 1.7 times net assets, compared with a five-year average of 2.2, data compiled by Bloomberg show. Fitch cut its outlook on Indian financial companies, including ICICI Bank and State Bank of India, to negative from stable on June 20.
Low interest rates around the world will buoy growth in the BRIC countries, said O’Neill, the former chief economist at Goldman Sachs Group Inc. The New York-based bank predicted two years after O’Neill coined the term that the countries would join the U.S. and Japan as the world’s biggest economies by
The Federal Reserve has kept its benchmark lending rate near zero since 2008 and last month extended a program to cut long-term borrowing costs by selling short-term securities and buying longer-term debt through December. The European Central Bank will probably cut its main rate on July 5, according to the median estimate of economists surveyed by Bloomberg. China reduced its lending rate last month, while Brazil has lowered its benchmark Selic rate seven times since August.
“The economic growth numbers are still going to be very good,” Mark Mobius, who oversees about $50 billion as the Singapore-based executive chairman of Templeton Emerging Markets Group, said in a phone interview yesterday. “Over the long term, we would expect the market cap to expand.”
MSCI’s BRIC index jumped an average 48 percent in the 12 months after policy makers began cutting borrowing costs in 2003, 2005 and 2008, according to data compiled by Bloomberg.
The gauge dropped 1.1 percent this year through yesterday, compared with a 4.6 percent gain in the MSCI All-Country index. The BRIC index trailed the global measure in the first half for the fourth straight six-month period, the longest stretch since the data began in 1994.
The emerging-country gauge is valued at 8.9 times earnings, down from an average multiple of 13 during the past three years and less than the ratio of 14 for the MSCI All-Country index, according to data compiled by Bloomberg.
“They are cheap now,” Burton Malkiel, an economics professor at Princeton University and author of “A Random Walk Down Wall Street,” said in a June 28 e-mail. Malkiel is the chief investment officer at Walnut Creek, California-based Baochuan Capital Management LLC, a money-management and advisory firm that oversees about $30 million.
Falling valuations for developing-nation shares spurred Jonathan Garner, the chief Asia and emerging-market strategist at Morgan Stanley, to recommend “maximum” overweight holdings, or 10 percent more than benchmark weights, on June 8. The last two times Garner turned this bullish, in December 2011 and October 2008, the MSCI BRIC index climbed at least 8 percent within three months.
“It’s not news that growth in emerging markets has been slow, and our argument is that it’s discounted in equity valuations,” Garner said in a June 26 phone interview. “What’s not discounted is the capability of emerging markets to generate GDP acceleration at some point in the second half.”
The Hong Kong-based strategist has overweight ratings on China and Russia and advises holding stocks in Brazil and India equal to their shares in benchmark indexes. Ctrip.com International Ltd., China’s biggest online travel agency, and Rosneft are among companies on Garner’s “focus list.”
Shanghai-based Ctrip is valued at 16 times profits, a record low, after tumbling 63 percent during the past year. Earnings will probably jump 22 percent in 2013, faster than the 19 percent median increase for global peers, according to analysts’ estimates compiled by Bloomberg.
Rosneft trades for 5.4 times earnings, compared with 9.1 times for MSCI’s gauge of global energy companies, according to data compiled by Bloomberg. The Moscow-based company has dropped 13 percent in the past year.
“The emerging markets are a place to be,” Byron Wien, the vice chairman of Blackstone Group LP’s advisory services unit, said in a June 26 interview on Bloomberg Radio in New York. “They’ve done poorly but now prices have come down to very attractive levels.”
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