How BRIC investing went bust

2015-09-07

Few investment concepts caught fire as quickly and convincingly as the "BRICs" — a catchy shorthand for the fast-growth economies of Brazil, Russia, India and China.

Coined by ex-Goldman Sachs economist Jim O'Neill in 2003, the BRICs epitomized the shift in global economic power away from the developed economies of the U.S., Europe and Japan toward these new stars of global economic universe.

Looking at the big picture, the rise of the BRICs was not just inevitable. It was already a done deal.

Taken together, the BRICs encompass more than 25% of the world's land mass and 40% of the world's population. And the combined Gross Domestic Product (GDP) of the BRICs comfortably exceed that of the United States. Adjust for Purchasing Power Parity (PPP), and the BRICs already account for 52% of the planet's GDP.

After the financial meltdown of 2008, investors flocked to the BRICs favoring them over stagnant, developed economies like Old Europe, aging Japan and the politically fractious and indebted United States. Not unreasonably, investors expected the value of their portfolios to rise with the prospects of these newly anointed kings.

BRIC investing breaks bad

Alas, things turned out very differently.

Today, U.S. markets trade within striking distance of their all-time highs. In contrast, the MSCI BRIC Index languishes 48% below its 2007 peak — the year the iPhone was launched and George Bush was still president. This year has been particularly unkind to BRIC investors.

Below is a quick look at how the BRICs have fared in the recent market turmoil.

China  

The Chinese stock market has been in the headlines often of late, collapsing pretty much as I had predicted in early June.

The latest news is that the Chinese government has thrown in the towel on supporting the stock market in a $200 billion spending spree funded by the central bank, local brokerages and commercial banks. Attention has shifted to Chinese journalists, who now are "confessing" to writing stories that stoke panic in the markets.

In the meantime, bad loans at China's banks have soared. China's largest bank — ICBC — reported its book of bad loans soared by 28% last quarter alone.

No wonder the "this time it's different" conviction that seemed to undergird China's dominance in the world has waned along with the size of investors' portfolios in the Chinese markets.

Deutsche X-trackers Harvest CSI300 CHN A ASHR, -4.53%   has fallen 41.68% over the past three months.

Brazil

The knock-on effects of the Chinese slowdown are particularly evident in Brazil. It turns out that Brazil's rise is just a commodity-linked bet on China. Brazil's exports to China tumbled by an astonishing 19% in the first seven months of this year. No wonder the economy is contracting. Economic growth in the second quarter came in worse than expected at minus 1.9%, with Brazil's economy contracting by a whopping 7.6% on annual basis. Meanwhile, inflation is nudging double digits. Plus, the government is cutting back on spending, exacerbating the contraction. Wealthy Brazilians are abandoning ship, snapping up properties in southern Florida.

As one commentator put it in the Wall Street Journal recently, "Brazil mania has turned to Brazil nausea."

iShares MSCI Brazil Capped EWZ, -4.66%  has fallen 28.73% over the past three months.

Russia

Senator John McCain once dismissed Russia as "a gas station masquerading as country." Over the past 18 months, the Russian economy has been hammered by the oil price and the costs of its increasing economic isolation and political adventurism.

At the same time, Russia is a value investor's dream: it is both hated and cheap. In fact, Russia is the second-cheapest market in the world on a long-term cyclically adjusted price earnings ("CAPE") basis.

Trading at a price-to-earnings (P/E) ratio of about 4.8, and a price-to-book ratio of 0.7, the Russian market trades at about half of the level of the broader MSCI Emerging Markets Index. Gazprom, the world's largest natural gas producer, trades at a P/E ratio of 5.

Here's the biggest surprise.

Despite the pullback in recent months, Russia is up 14.97% for 2015. That makes it the third-best-performing market of 2015 among the 47 markets I track at my firm, Global Guru Capital.

That said, Market Vectors Russia ETF RSX, -2.84%  has fallen 17.25% in the past three months.

India

India has long suffered in the shadow of China, its economy held back by the messy politics of a democracy, lousy infrastructure, and ever-rampant corruption. No wonder Indian officials are now gloating over the Chinese economy's well-publicized stumbles.

That's largely because for the first time in recent memory, India's GDP growth is set to exceed that of China in 2015, (7.7% vs. 6.9%.) And even that's assuming you accept China's seriously fuzzy economic statistics.

That said, some critics are equally suspect of India's projections dismissing them too good to be true. Most worrisome is that Prime Minister Modi's reforms have bogged down in parliament, as investment in industry and infrastructure has ground to a halt.

The WisdomTree India Earnings ETF EPI, -4.00%  has fallen 11.17% over the past three months.

No “Cheery Consensus” for the BRICs

As Warren Buffett has noted, "markets pay dearly for a cheery consensus."

And the current consensus surrounding BRICs is anything but cheery.

Nor is the outlook much better. Growth in emerging markets is slowing with a projected growth rate of 3.6% in 2015. That's the lowest level since 2001, excluding the crisis year of 2009. And if China's growth is closer to 4%, as many suspect, that emerging-markets growth number withers to 2.7%.

Yes, the BRICs are now hated and relatively cheap.

But you've got to be a dyed-in-the-wool contrarian to bet on the near-term prospects of the BRICs anytime soon.