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Signs of a recovery are showing up in some surprising places – particularly, the BRIC (Brazil, Russia, India and China) exchange traded funds (ETFs). As the global economy collapsed all around us, many seemed to have written off these fledgling economies.
The BRIC countries have woven an interesting story of their own in recent years that has made them standouts among emerging markets. From 2003-2007, these regions were among the fastest-growing in the world, with funds focused on them delivering returns of at least 70% in that time frame. Then came along a Great Recession that stopped growth in markets of all types in their tracks.
However, recent weeks have seen emerging economies – especially the BRICs – awakening from their slumber and it’s time to consider new opportunities in these areas and how they may benefit us.
The theory of decoupling, which is the ability for an economy to grow on its own without assistance from other countries, has been laid to rest for the time being. The United States depends on these countries for imports and they’re dependent on us to continue to buy the materials they produce.
Now that BRICs have surged above their 200-day moving averages, it’s time to revisit them, see what’s been happening, where they’ve been and where they’re going from here.
ETFs have made it easier and more cost effective than ever for investors to gain exposure to the emerging markets, mostly by eliminating the guesswork of stock picking. Although researching large companies is not a daunting task, getting information about a smaller company in India might yield few results. Enter an emerging-market fund, where the legwork not only has been done for you, but you can invest in dozens of companies in one swoop, spreading your risk around.
Also numerous choices exist among ETFs. You can focus on a single country, such as Brazil, or you can just buy one fund that gives you exposure to all four BRICs.
BRAZIL
- The heavy influence of the government in the financial sector. In fact, retail bank giant Banco de Brasil, the nation’s largest mortgage lender, Caixa Economica , and BNDES, a big development bank that feeds credit to favored companies are all controlled by the government. While the rest of the world is figuring out how to get a handle on banks, Brazil has been doing it all along.
- Hugely expensive bank loans, meaning fewer people in debt.
- Huge reserve requirements and taxes on funding that push up the price of loans discouraged private banks from taking wild risks and jumping on the bandwagon that some of its peers in Europe and the United States did.
- Public-sector debt is below 40% of GDP, previously a problem in the nation.
- Foreign currency borrowings have been exchanged for the Brazilian real (their currency) dominated ones, so fluctuations in the real will not hinder the government’s balance sheet; Brazil has actually built up a reserve of about $200 billion to defend its currency.
- The economic crisis isn’t pushing up inflation, which has been an ongoing problem in the nation. This has enabled the central bank to cut interest rates.
Latin American countries have been undergoing large infrastructure programs and they are likely to continue after the global recession has abated. The government’s growth acceleration program will continue into 2010, and it includes $231 billion for social, transport infrastructure and energy projects. In the second quarter of 2008, civil engineering progressed 10% higher than for the same quarter in 2007. A National Plan for Logistics and Transportation will also continue into 2023, including a budget of $79 billion.
A series of other factors that favor the economy include:
- Seasons. The Brazilian Bovespa stock index has a seasonal rhythm and the peaks tend to lie between the end of October and end of May. It is calculated that the average gain per period was around 16.4%.
- Trends. The intermediate trend is up with the MSCI index above its long-term trend line, the 200-day moving average.
- Fundamentals. Brazil is still a major producer of copper, crude oil, gold, silver, iron ore and coal. All of these commodities are still in demand and that demand is on the rise.
- Performance. As of May 27, Brazil’s index, the Bovespa, is up 28.8% year-to-date; the S&P 500 by comparison is up 0.8%.
- Optimism. Brazil’s government has gleefully estimated a 2% growth for GDP this year.
Ways to Play Brazil
RUSSIA
Second, Russia’s economy has been seen as far too dependent on oil. Oil’s record-setting run benefited the economy enormously and left it with vast reserves of cash, but as soon as the bubble burst, Russia found itself without other sectors to lean on in bad times and its reserves are dwindling.
Finance minister Aleksei L. Kudrin has assured that the government is not in desperate need of financing, but is open to holding a road show in allowing foreign investors to get acquainted with Russian finances.
Foreign borrowing is seen as a way to help the economy by determining a benchmark rate for loans to corporations that are borrowing from Western banks.
One question, though: with credit markets so tight, is anyone actually going to loan money to Russia?
Due to its $385 billion in reserves, the world’s third largest reserve fund, Russia’s credit rating is still strong and it could even draw down its reserves without having to borrow from abroad. In 2010, the government may borrow $5 billion to test things out.
Under Secretary for Political Affairs William J. Burns noted in a recent speech that the relationship between Russia and the United States has five major points that need to be addressed:
- Finish a legally binding treaty on the reduction and limitation of strategic offensive arms
- Reduce the threat of nuclear weapon proliferation to unscrupulous regimes or terrorist groups, and safeguard the peaceful use of nuclear technology
- Help resolve conflicts in areas such as Pakistan, Afghanistan and the Middle East, and protect the sovereignty of independent states
- Ease the international financial crisis, expand Russian-American economic ties and include Russia into global economic institutions
- Commit to a way to help lessen or stop the further degradation of the environment
Ways to Play Russia
- Market Vectors Russia (RSX)
INDIA
During the slowdown, India’s construction came to a grinding halt, the luxury art market slowed and even the most educated of its population were having trouble finding employment.
During the boom years, India’s growth was attributed to large inflows of cash and investments, around 39% of GDP in 2008, with more than a third coming in from abroad. In the last 3 months of last year, foreign loan and direct investment plummeted almost a third.
The International Monetary Fund (IMF) has reported that Indian companies are among the world’s most exposed as a result of heavy borrowing. On the other hand, financial corporations in India weren’t weighed down by toxic assets, which wound up insulating them somewhat from the full impact of the global recession.
In the fourth quarter of 2008, the economy grew 5.3%, the slowest rate in five years. The government predicts a 6% growth this year while the IMF projects a 4.5% growth. There will be increased fiscal spending on infrastructure and social programs, and the Central Bank has reduced its benchmark interest rates.
A recent election, however, could reverse the country’s course. The day the Congress Party won the elections, the stock market shot up a whopping 17%. No wonder they were dancing in the streets. The victory raised hopes of a revival in foreign direct investment and economic growth, as well as tax reform and significant infrastructure spending.
Manmohan Singh’s win has given hope to a half a billion Indians that poverty isn’t a way of life.
Ways to Play India
CHINA
China’s economy, while still considered “emerging,” is considered one of the world’s economic superpowers. It’s the second largest in the world, and as one of largest buyers of U.S. debt, the relationship we share is a significant one.
Many economists believe that China’s economy will be the fastest-growing one in 2009. While the country suffered in the economic downturn and saw massive job losses, it also forcefully reacted to the downward pressure with $580 billion stimulus spending package that by many accounts is working.
China’s Central Bank also stepped in and prioritized the maintenance of stable economic growth by relaxing monetary policies and ensuring sufficient liquidity. The bank also kept the yuan stable at a balanced level with a more flexible exchange rate.
In the meantime, China is trying to increase its influence with more overseas aid and loans, and top officials are setting up the country as the world’s next top economic power. There have been talks of a “Beijing Consensus” that might displace the Washington Consensus, which is a set of ten specific economic policy prescriptions that lays out how developing countries should manage their own economies.
While China is growing and powerful, there are still some hindrances to its growth: energy is insufficient to run at fully-installed industrial capacity; the transport system isn’t efficient enough to move mass quantities of critical items such as coal; the communications system isn’t able to meet the needs of a population as large as China’s.
One facet of China’s economy that might pay off in the long run is that consumer spending only makes up 35% of China’s GDP. The culture of thrift in China has caused massive amounts of household savings. But tax cuts and the government’s focus on infrastructure projects aims to help households. There is also a health insurance plan that would be provided to hundreds of millions more people over the next couple of years.
Ways to Play China
- iShares FTSE/Xinhua China 25 (FXI)
- PowerShares Golden Dragon Halter USX China (PGJ)
- SPDR S&P China (GXC)
- Claymore/AlphaShares China Small Cap (HAO)
How to Choose the Best ETF for You
If you are hungry for exposure to the BRICs and other emerging markets, ETFs can give it to you in a variety of ways, including two of the most common:
- Target a specific emerging market with a single-country fund, such as any of the ones listed above, which can potentially deliver higher volatility but greater rewards when they do well; or…
- You can choose a region or class of emerging markets with a broad-based fund, which spreads the risk and volatility over several emerging-market countries
As you decide which option works best for you, decide what your comfort level is, what areas are most interesting to you and how much risk you would like to take. It’s also important to watch the trend lines and look for those areas that are moving.
When you’re looking at a broad BRIC fund, it’s important to look at the allocations. None of them have an equal weighting across all four countries. In fact, most of them allocate at least one-third to one country, while the rest of the countries are spread out among the remaining two-thirds.
Ways to Play the BRICs
- iShares MSCI BRIC (BKF): Brazil, 27.4%; China, 23.5%; India, 13.9%; Hong Kong, 12.9% and Russia, 11.9%
- Claymore/BNY BRIC (EEB): Brazil, 52.8%; China, 18.3%; Hong Kong, 15%; India, 9.2% and Russia, 3.6%
- SPDR S&P BRIC 40 (BIK): China, 31.6%; Brazil, 23.9%; Russia, 23.2%; Hong Kong, 13.7% and India 6.2%
- First Trust ISE Chindia (FNI): China, 40.7%; India, 35.6%; Hong Kong, 13.6%
For full disclosure, some of Tom Lydon’s clients own shares of GXC and EEB.