Some of the BRICS are looking rather worn just as some emerging emerging markets are taking off

11/09/2012 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Something not so funny has happened on the road to the future. The BRICS markets that were supposed to pave that road have crumbled—by and large—and some of them have even turned into potholes.

Oddly enough, the emerging markets that look like the best road now to future profits are much, much smaller than the BRICS—Brazil, Russia, India, China, and South Africa—and don’t even register in many investors’ portfolios.

And on the evidence they should. Most of us should own more stocks from Chile, Colombia, and Mexico, from Turkey, the Philippines, and Singapore, from Nigeria and Kenya than we do. It’s not easy—I spend my days looking for great companies to buy in those markets for my mutual fund Jubak Global Equity (JUBAX) and I can tell you it's a hard search. But it is possible. And I think that search is crucial to building a portfolio for the emerging, emerging markets world.

There’s nothing especially wrong with the BRICS markets—except that in the cases of Russia, India, and South Africa those economies have developed deep, deep problems. And that across the BRICS group as a whole, many of biggest of emerging markets have underperformed their smaller peers.

Drum roll: some numbers, please.

Established BRICS: iShares MSCI Brazil (EWZ) down 3.86% in 2012 through November 7; iShares MSCI Russia (ERUS) up 4.26%; iShares MSCI China (MCHI) up 14.63% in 2012 to date; and iShares MSCI South Africa (EZA) up 11.23%.

Not bad, you say. I’d agree. The U.S. Standard & Poor’s 500 is up 9.53% year to date through November 7.

Now, the emerging emerging markets: iShares MSCI Turkey (TUR) 50.79% in 2012 through November 7; iShares MSCI Chile (ECH) up 8.86% to date; Mexico Bolsa (MEXBOLD) up 10.12%; iShares MSCI Singapore (EWS) up 23.73%; and iShares Philippines (EPHE) up 35.90%.

What intrigues me about these emerging emerging markets, even after some of them have had this run, is that the fundamentals driving these stocks are by no means exhausted. Besides the usual developing economy story—above global average GDP growth leads to rising incomes which leads to rising demand for everything from chickens to appliances to education—the emerging emerging markets that I’ve flagged are getting the benefit of sounder than average monetary and economic policies that are moving these countries up the credit quality scale. Turkey, for example, has just got an upgrade from Fitch Ratings to BB+ from BBB-. That moves the country up to investment grade for the first time in almost 20 years.

You can find similar stories at most of these other emerging emerging economies. This fall Moody’s Investors Service began talking about raising Mexico’s credit rating to A3 from Baa1. Moody’s last upgraded Mexico in 2005. Moody’s and Standard & Poor’s both raised Colombia’s credit rating to investment grade in 2011 and in August S%P upgraded Colombia from stable to positive, a sign that the country could get another upgrade in 2013. Standard & Poor’s raised its rating on the Philippines to BB+, one step below investment grade in August and in October Moody’s moved the country to Ba1, also one rung below investment grade.

With many of these emerging emerging markets just making the transition to investment grade now, there’s still plenty of room for future improvement.

Why do you care about this trend? A higher credit rating lets a country attract capital at a lower interest rate and that stimulates the domestic economy. Expanding or starting a business gets cheaper. Financing a new consumer purchase of a new home gets cheaper.

And the contrast to what’s happening in the world’s largest economies is gradually catching investors’ eyes. At a time when the United States, Japan, and much of Europe are facing down grades, these emerging emerging market economies are looking like better risks.

Of course, these economies still exist in the same world as China and the United States and other big global economic powers. A slowdown in the Chinese or U.S. economy hurts the export sectors in these economies. But even then so robust is domestic growth that these countries have a better chance of coming through with decent growth, especially since healthy fiscal and monetary policies give these governments some room to run counter-cyclical economic policies.

What I’ve been looking for over the last year and more, then, are solid domestically oriented companies with a strong consumer bias. I’m certainly not adverse to a company that combines those qualities with an export business as long as the company has found a way to diversify its sales to make up for the slowdown in the world’s big developed economies.

I’ve got a few suggestions for you to research and add to your portfolios. When do you want to buy? I’d suggest dollar cost averaging into these stocks. While they are long-term picks, these stocks do have enough volatility so that you’d like to buy more when the price is low and fewer when the price is high.

My favorites in Turkey include Anadolu Efes (EFES in Istanbul), a producer of beer and a bottler of Coca-Cola that sells in a market that stretches from Russia and Eastern Europe throughout the Middle East, and Arcelik (ARCLK in Istanbul), which sells its refrigerators, washing machines, cooking appliances, and vacuum cleaners in more than 100 countries and is the third largest appliance maker in Europe.

In Mexico I like Grupo Televisa (TV in New York), the second largest media conglomerate in Latin America and provider of an increasing amount of Spanish-language content in the United States through its relationship with Univision, and Industrias Bachoco (BACHOCOB in Mexico City), the country’s largest poultry producer.

In Chile I’d go with CorpBanca (BCA in New York), Chile’s fifth largest bank and a major beneficiary of the pullback of Spanish banks in Latin America (CorpBanca bought Banco Santander’s (SAN) Colombian unit in December 2011), and Latam Airlines (LFL), the dominant airline in Latin America.

Does this mean that I’d recommend ignoring the BRICS right now? No, but I would concentrate on the two most promising BRICS and leave Russia, South Africa, and India under represented in my portfolio until these countries work through their current near-crisis economic problems.

In Brazil and China for long-term bets I’d concentrate on domestic companies, rather than exporters (good for short-term rallies, in my opinion) because they are best positioned to take advantage of the huge and expanding consumer markets in those two countries. In China that means companies such as Internet giant Tencent Holdings (700.HK in Hong Kong or TCEHY in New York) and insurer Ping An (2318 in Hong Kong or PNGAY in New York.)

Right now I find Brazil more interesting from a long-term perspective than China. Maybe China’s new leadership will tackle the huge problems of corruption, a lack of an effective legal system fro property rights, and an absence of any effective check on state economic power, but I have my doubts. Changes in those realms are necessary if China’s economy is to take the next step of development. Without them, I think China risks getting trapped in a global role of a manufacturer—perhaps an increasingly advance manufacturer—of goods for companies from other economies.

Brazil seems—and I stress “seems”—to recognize this challenge and to be making an effort to differentiate itself from its big BRICS trading partner and competitor. Not only does the administration of President Dilma Rousseff seem intent on breaking Brazil’s long history of double digit interest rates, but also seems determined to at least make a start on tackling Brazil’s deep-seated tradition of the rich and powerful flouting the law. (Yeah, I don’t mean it doesn’t happen everywhere. It’s just a matter of degree but degree is important.)  In the current Banco Cruzeiro do Sul fraud trial, for example, the police are actually investigating the former owners of the mid-sized bank. Two of the accused are actually in jail without bail—not exactly common in trials of the connected in Brazil. This comes after the Supreme Court has convicted some of the country’s most senior former politicians of corruption and vote buying. The two cases have led some in Brazil to believe that the culture is actually changing. And that would be a big deal for Brazil and its journey to join the ranks of the world’s developed economies.

My favorites in Brazil are private education companies Kroton Educacional (KROT11.BZ in Sao Paulo) and Anhanguerra Educacional (AEDU3.BZ in Sao Paulo), and Naturas Cosmetico (NATU3.BZ in Sao Paulo), Latin America’s largest cosmetics company.

Many of the stocks I have mentioned don’t trade in New York, or at least not in volumes that make exits and entrances cheap or easy. I think that’s partly a reflection of a world where national companies in emerging economies are more comfortable and more able to raise money in local financial markets. U.S. based brokers, in response, are increasingly offering their account holders the power to trade in local markets. Charles Schwab, for example, just added trading in a dozen local markets to its list of services. These days if you see a stock you like, it never hurts to ask if you can buy it in the local market.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. As of the end of September the fund owned shares in Anadolu Efes, Banco Santander, CorpBanca, Industrias Bachoco, Kroton Educacional, Naturas Cosmetico, Ping An Insurance, and Tencent Holdings. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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