BRIC Rally’s Weak Point Exposed in Brazilian SelloffWeiyi Lim, Ye Xie and Kyoungwha Kim
The rout in Brazil’s stocks and currency on the final trading day of May wiped out what was to be the first pan-market monthly advance in the four biggest developing countries since 2010.
While markets are rebounding today, the selloff on May 30 highlights a fundamental weakness in the rally that has spread across Brazil, Russia, India and China: Growth is slowing. It was a report showing Brazil’s economic expansion weakened in the first quarter that triggered the 1.9 percent plunge in the equity benchmark index and 0.8 percent slump in the real, erasing their monthly gains.
The slowest growth in the so-called BRIC nations since 2009 will undercut gains that have been predicated on record low interest rates in the U.S. and Europe and markets that remain cheap relative to their developed peers, according to UBS AG and Deutsche Bank AG. Stocks from the four countries added $260 billion in market value last month as Russia’s Micex index erased its losses since President Vladimir Putin’s incursion into Crimea. India’s rupee climbed to an 11-month high, while China’s government bonds posted the biggest gain since 2008.
“I don’t see why non-EM dedicated investors would want to have much in the way of exposure to EM equities at present,” John-Paul Smith, a London-based emerging-market strategist at Deutsche Bank who cut his recommendation on Indian stocks to neutral last month and said the other three BRIC markets are even less attractive, wrote in an e-mail on May 28. “The secular underperformance story is still unfinished business.”
Russia’s Micex jumped 9.7 percent in May, the most since October 2011, and the ruble added 2.2 percent as Putin’s withdrawal of troops from Ukraine’s borders eased concern about tougher sanctions from the U.S. and the European Union. India’s S&P BSE Sensex Index surged 8 percent to a record amid optimism that Prime Minister Narendra Modi will revive economic growth following the strongest electoral mandate in 30 years.
China’s government bonds advanced 2 percent, the biggest increase since September 2008, according to a Bank of America Corp. gauge, as policy makers injected cash to the financial system to bolster the economy. The yuan strengthened 0.2 percent for its first monthly increase of 2014.
Brazil’s May 30 stock losses sent the Ibovespa equity index down 0.8 percent for the month. That ended a two-month rally that was triggered by speculation President Dilma Rousseff’s falling support in polls may lead to an improvement in economic policies.
The gains mirrored the advance in other developing-country assets. The MSCI Emerging Markets Index of stocks rose 3.3 percent in May to a seven-month high, while the Bloomberg gauge of emerging-market local-currency bonds returned 2.5 percent. The rally started in mid-March and followed what was the worst January in any year since 2009, as Argentina devalued the peso and political protests in Ukraine and Thailand erupted into violence.
Brazil’s Ibovespa benchmark advanced 0.8 percent and the MSCI emerging-markets gauge rose 0.1 percent at 11:40 a.m. in New York. Russia’s Micex Index climbed 2.3 percent and the Sensex in India added 1.9 percent today. China’s markets were shut for a holiday.
Lower borrowing costs in major economies have reduced bond and stock swings, helping spur demand for higher-yielding BRIC assets. The European Central Bank will cut its benchmark interest rate from 0.25 percent at a policy meeting June 5, according a Bloomberg survey of economists.
Brazil’s gross domestic product increased 1.9 percent in the first quarter from a year earlier, compared with 2.2 percent in the final three months of 2013, as investment declined the most in two years, a government report showed on May 30. India reported the same day that the economy grew 4.6 percent in the three months ended March, down from an average growth of 7.6 percent since June 2005.
Economists surveyed by Bloomberg forecast average growth in the BRICS, which also includes South Africa, will be 5.3 percent this year, the slowest since 2009. It was 8.7 percent in 2010.
“Is the rally built on a solid foundation? I doubt it,” Stephen Jen, co-founder of SLJ Macro Partners LLP and a former International Monetary Fund economist, said in a phone interview on May 30 from London.
Even after the gains last month, the assets of Brazil, Russia, India and China are still cheap relative to their global peers after three years of underperformance.
The MSCI BRIC Index is valued at 1.3 times net assets, a 36 percent discount versus global equities. At 11.6 percent, yields on two-year Brazilian real-denominated bonds are 11.2 percentage points higher than U.S. Treasuries with similar maturity, according to data compiled by Bloomberg. That compares with an average difference of 9.8 percentage points over the past three years.
“Many of them have a lot of value, and contrary to what some people wrote at the start of the year, the emerging-market story is far from over,” Jim O’Neill, the former chairman of Goldman Sachs Asset Management who coined the BRIC acronym in 2001 and is now a contributor to Bloomberg View, the opinion section of Bloomberg News, said by e-mail on May 29.
Bears are unwinding options wagers against emerging-market stocks. Contracts on an exchange-traded fund tracking countries including Brazil, Russia, India and China fell to the cheapest in a year relative to U.S. stocks, data compiled by Bloomberg showed. The iShares MSCI Emerging Markets ETF has rallied 15 percent since hitting a seven-month low in February, compared with a 10 percent gain in the Standard & Poor’s 500 Index.
Growth is picking up in the U.S. and Europe, boosting demand for exports from developing countries. American economic data beat analyst forecasts in May by the most in five months, according to Bloomberg’s Economic Surprise Index. China’s manufacturing expanded last month at the fastest pace since December, a report showed June 1.
Investment flow into the four countries slowed last month. Global investors added $1.5 billion to stock and bond funds focused on these markets in May, down from $2.4 billion in April, according to EPFR Global data. That pared the outflow this year to $2.6 billion.
Since September 2010, the last time all BRIC currencies, bonds and stocks rallied in tandem, about $386 billion in equity market value has been destroyed. Investors fled the countries as bad bank loans rose to a five-year high in China, inflation in Brazil approached the government’s target, trade and budget deficits in India widened and corporate governance deteriorated in Russia.
On average, companies in the MSCI BRIC index reported first-quarter earnings 40 percent below analysts’ forecast, data compiled by Bloomberg show.
While UBS strategist Bhanu Baweja reversed his long-term bearish view on the Indian rupee amid expectations Modi’s government will revive growth, he’s advising clients to sell Russia’s ruble and buy credit default swaps on Brazil to profit from the country’s worsening fiscal balance.
“From here, we’ve got to be careful,” Baweja, the head of emerging-market cross-asset strategy at UBS in London, said by telephone on May 30. “It will be a sell into the rally.”