(06/25/12) BRICs Fight to Stay Relevant

As the economic crisis in Europe continues, and the US economy can’t seem to gain traction, the BRICS (Brazil, Russia, India, China, South Africa), the poster children of the developing markets, are vying for investors’ attention, writes Harvey Jones of The National.

It’s the financial battle of the 21st century, and every investor has a stake in the result.

Brazil, Russia, India, and China are slugging it out for the title of global economic superpower. So who will win the battle of the BRICS?

Despite the hype, these emerging heavyweights have been looking a little shaky lately. Over the past 12 months, share prices in Brazil, India, and China plunged by about 25%, according to the MSCI Emerging Markets Index. The Indian stock market fell nearly 30%.

India is ready to fight back, says Ajay Argal, the head of Indian equities at Baring Asset Management. "It has the most favorable demographics of all the BRICS, which is tremendously positive for growth and development. The country’s youthful population now has a taste for consumer goods, while demand for housing and financial services will strengthen as the pace of urbanization accelerates."

The Indian government is set to invest $1 trillion on upgrading the country’s roads and energy sector, which should further boost productivity and growth.

India has another advantage. "Its main export is information technology services, where its well-educated workforce and cost advantages make it a global leader. These services tend to be supplied on a long-term contract basis, providing India with a degree of shelter from the extremes of the global economic cycle," Argal says.

Yet India is the most expensive BRIC to invest in, as judged by P/E ratio. This divides share prices by earnings to show whether a company or market is under- or overvalued, with a score of about 15 times earnings representing fair value.

Following recent falls, India is now on a modest P/E of 16. That makes it a lot more expensive than China, the world’s second-biggest economy, which trades at just seven times earnings.

China is still the BRIC to beat, says Stuart Parks, the head of Asian equities at Invesco Perpetual. "Nowhere else offers the combination of cheapness, scale, infrastructure, and stability."

It also boasts high levels of savings, a solvent banking system, and a willingness to change. This last factor is important as it looks to move on from its export-led economic model.

"China’s export markets are likely to remain subdued for some time," says Parks. "Its share of world trade, although still growing, cannot continue to increase at such a strong rate, particularly when its wage growth is reducing competitiveness."

The days of double-digit annual growth may soon be over, but China will continue to grow. "I don’t know what the sustainable rate of growth for China will be, nobody does. But I do know the most important building blocks remain in place."

Parks admits that China also has plenty of challenges. "Negatives include the lack of domestic resources and agricultural land, unhealthy storage of wealth in high-end city properties, its aging population, and endemic corruption," he says.

He still believes China can avoid a hard landing. So does Bob Doll, the chief equity strategist at BlackRock, the fund manager. "Some are forecasting that China will enter a spiral of slower growth and rising inflation but such fears are overblown," he says. "True, growth is slowing, but not at a pace that should trigger any sort of calamity."

Last December, Brazil overtook the UK to become the world’s sixth-largest economy. It is also the second-biggest BRIC. Brazil is rich in natural resources and a big exporter of soy, iron ore, and steel to booming China.

This Latin American giant has more to offer than natural resources, says Nick Robinson, the head of Brazilian equities at Aberdeen Asset Management.

"Around half the companies listed on its stock exchange are energy, mining,, or commodity companies, but they only make up around 10% of Brazilian GDP. Domestic consumption is much more important, and that’s rising strongly."

The Brazilian government has slashed interest rates from 12% to 9%, and launched a massive fiscal stimulus program in a bid to offset the global slowdown.

Brazil has one big advantage over China and Russia, Robinson says. "In China, most companies are run for the benefit of the government rather than private shareholders. In Russia, corruption is endemic, and it is hard to find companies you can trust. Brazil has dramatically improved corporate governance, and this has made it attractive to foreign investors," he says.

Brazil trades at a relatively cheap 11 times earnings, but the cheapest BRIC of them all is Russia, at a mere five times earnings. However, Russia is cheap for a reason, says James Thomas, the regional director at Acuma Wealth Management in Dubai.

"It is the world’s biggest exporter of oil and gas," he says. "That made Russia attractive when prices were rising, but this dependency has its dangers, especially if oil prices continue to fall."

The BRICS still offer great growth prospects, provided you understand the risks. "They are growing quickly, as people move from the fields to the cities, earn more income, become consumers, and fuel growth. The question is whether this will continue to happen fast enough to keep the growth story going," Thomas says.

Each has their own problems. China has a housing bubble. India has budgetary problems. Brazilian growth fell from 7.5% in 2010 to just 2.7% last year. Russia is dangerously dependent on high energy prices.

All four are vulnerable to a sucker punch from the financial crisis, Thomas says. "Despite that, I still believe the BRICS and other emerging markets offer the potential for good returns and should be part of your portfolio, provided you are comfortable riding the investment roller coaster."

Investors should remember that sky-high GDP growth doesn’t always translate into strong investment returns. China may have routinely posted double-digit GDP growth, but its markets are down 9% over the past three years.

Over the same period, Brazil returned just 2%. India and Russia did better, growing 12% and 18% respectively. But all of them were thrashed by the S&P 500, which grew 47%.

The BRICS are impressive pretenders for the global economic crown, but as far as investors are concerned, the US is still the superpower to beat.