BLOG: Why it’s not the end of the road for the BRIC economies

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04/10/2013
Emerging markets have had a rough ride but sticking with the BRIC countries could prove profitable, writes Darius McDermott.
BLOG: Why it’s not the end of the road for the BRIC economies

The BRICs acronym was coined by Jim O’Neill, a Goldman Sachs’ economist, in 2001 to describe the emerging markets with the most growth potential, namely Brazil, Russia, India and China.

They were singled out primarily because of their size, which meant that their rapid growth would have a huge and unprecedented impact on the global economy.

This prediction culminated in 2007, with China growing at an eye-watering 14.2%, India at 10.1%, Russia 8.5% and Brazil 6.3%. Consequently, these economies now account for 25% of global GDP and roughly 40% of the world’s population.

However, with the emerging markets suffering huge capital outflows since Fed chairman Ben Bernanke’s “tapering” comments, I thought it would be interesting to have a look at the prospects for the BRICs going forward.

The first thing to say is that the one thing they all have in common is that their respective stock markets are all cheap.

Russia

At the moment, the Russian stock market is the cheapest of the four. However, if you break it down and have a closer look, about 60% of the market is in Russian oil companies and these are the basement bargains.

And they are cheap for a good reason – most are partially state owned and at the whim of the Kremlin. Also, the advent of shale gas has caused the gas price to plummet, which has negatively impacted the share price of Gazprom, the world’s largest gas producer and one of the biggest companies in Russia.

The rest of the market is not quite as cheap and, with unemployment at 5.5% (effectively full employment), which is driving up labour costs it’s hard to imagine a catalyst for the Russian stock market to re-rate in the near term.

Brazil

Brazil has been one of the main benefactors of the commodity boom over the last 20 years. However, with demand slowing for raw materials, this has severely impacted growth and seen the current account deficit balloon. Another issue is that inflation is running at 6.5%, which may lead to rate rises which in turn may choke off growth altogether. Also, despite the opportunities afforded by record low unemployment there has been a lack of investment in infrastructure (the World Cup and Olympics aside) and public services, which has led to civil unrest.

That said the long-term economic drivers remain in place, valuations are very cheap and, with consensus opinion so negative, an adventurous investor may see the current situation as a buying opportunity.

India

Growth has stalled, the currency has devalued, inflation is persistent and the country is running a current account deficit. This has meant that India has been hit particularly hard by the American central bank’s intention to slow QE.

In response to this, the Indian government has tightened capital controls, to prevent locals pulling their money out of the country, which has spooked foreign investors even more and led to further declines.

However, one of the main hindrances to India’s economic development is the government’s lack of structural reforms, which is holding back investment. Instead, the government is focused on short-term policies that will help it get re-elected when the country goes to the polls in the middle of next year. Despite all of this, the country has a young and growing population, which in turn should reward the long-term investor, provided the government implements the necessary reforms.

China

China’s current account surplus, huge foreign exchange reserves, 7.5% GDP growth and cheap valuations have meant that the Chinese market has been relatively unaffected by the recent rout in emerging markets.

It seems that the government has avoided a hard landing but still has the tricky task of managing an economy from being investment-led to consumption-led. One area for concern is China’s one child policy, which means the country will become old before it becomes rich, and its population, by some estimates, is set to peak in 2015. However, it is still likely to become the largest economy in the world sometime in the next decade and many of the long-term investment drivers are still in place.

All the BRIC markets are very cheap at the moment, and usually when valuations are this low, it’s a good time to invest but it’s hard to say what the catalyst will be for the current trend to reverse in some of the four.

For some time I have been bullish on developed market equities, particularly the US but, with profits relative to GDP in the US already at post-war highs, sticking with some of the BRICs or the emerging markets in general, provided you are prepared for a few bumps along the way, may well prove to be a good position in the very long term.

Darius McDermott is managing director of Chelsea Financial Services

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