A few weeks back, I kicked off the Intelligent Investor Series as part of my weekly commentaries. Th...
5 Strong Stocks from Stealth Markets
04/26/2013 9:00 am EST
The once-hot markets known as the BRICS—Brazil, Russia, India, China, and South Africa—are cooling off. So you'll find the best plays in economies just starting to emerge, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
Whatever happened to the BRICS? Remember them?
The stock markets of Brazil, Russia, India, China, and South Africa were supposed to leave the rest of the world in the dust. The BRICS were the best new idea since hand-pulled noodles.
Lagging performance is what happened. In 2012, the S&P 500 returned 16%. Year to date, as of April 24, the return was 10.61%. The five-year average annual return was 5.05%
And for the BRICS? For the purposes of these numbers, I'm using an index that tracks the BRIC countries without South Africa. The return in 2012 was 15.2%, and the year-to-date return in 2013 is a loss of 4.87%. For five years, the average annual return was a loss of 5.75%.
Who needs an asset class that underperforms, and that is also thought to come with greater risk than developed markets like the US? It's no wonder investors have turned away.
But I don't think this is the time to throw out the emerging-market baby with the BRICS bathwater. Here's why.
Even Better Emerging Markets
A funny thing (that's funny peculiar, not funny ha-ha) has been going on while the BRIC stocks have been underperforming the US market.
Other emerging markets—a group without a catchy name but that I'll call the emerging-emerging markets—has been outperforming both the BRICS and the US markets. Take a look at these numbers:
- The iShares MSCI Turkey ETF (TUR) was up 65.63% in 2012 and is up 6.68% year to date. The five-year average annual return has been 8.84%.
- The iShares MSCI Mexico ETF (EWW) was up 32.84% in 2012 and is up 5.76% year to date. The five-year average annual return has been 5.05%.
- The iShares MSCI Indonesia ETF (EIDO) was up 4.55% in 2012 and is up 15.14% year to date. The five-year average annual return has been—well, the ETF hasn't been in business that long.
- The iShares MSCI Philippines ETF (EPHE) was up 47.93% in 2012 and is up 19.07% year to date. There's no five-year track record for this ETF, either.
What's going on? And what should you as an investor do about it?
What's going on is remarkably easy to explain.
Hitting a BRIC Wall
First, economic growth rates in the BRIC countries, while high by developed-economy standards, have been trending downward.
India's gross domestic product is projected to have grown by just 5% in the fiscal year that ended on March 31. That would be the slowest growth in a decade. In Russia, GDP growth fell to an annual 0.1% in February, below even the 0.9% year-over-year growth in January and February. Brazil's growth rate slowed from 7.5% in 2010 to 0.9% in 2012, and the consensus is for 3% growth in 2013.
China shows the highest GDP growth in the group, but even there, growth looks like it will slow for 2013 from the 7.8% recorded in 2012. And 2012's growth was the slowest in 13 years.
Second, the BRIC countries seem to have hit tough economic barriers that suggest growth will stay at these levels for a while, and might even drop lower. In the case of China and Brazil, the barrier is something economists call the middle-income trap.
This trap sets in when a country that has used cheap labor to fuel development based on low-priced exports finds that its living standards have improved so much (and its supply of cheap, usually rural labor has dried up) that it is no longer the low-cost export platform in a range of core industries. At that point, a country can get stuck in place, or after wrenching change—as in South Korea and Japan—break out of that trap.
China faces that transition now. Brazil's problem is similar, but has the added wrinkles of a heavily commodity-dependent economy and a grossly inefficient public sector.
Russia seems now to be confronting its overreliance on energy exports to prop up an inefficient economy. With oil prices below the levels that the government needs to balance its budget and subsidize services and consumer goods, the economy seems headed for a crisis.
India? Well, what can we say about India? The infrastructure is shoddy, the school system produces too many graduates who aren't ready for work, and endless rules keep foreign investment to a minimum. Only India's stifling bureaucracy is truly world-class.
Third, the financial ratings of these countries are headed in the wrong direction. China's credit rating was cut to A+ from AA- by Fitch Ratings in early April. In March, Moody's affirmed Russia's Baaa1 credit rating, the third-lowest investment grade rating, but no credit company has upgraded Russia in five years.
Rumors say that the ratings companies are about to downgrade Brazil. Moody's gives India a Baa3 rating, the lowest investment grade, and that company is the only one of the Big Three ratings companies to give India a stable rating.
Where the Growth Will Be
Now contrast this picture with the story at the emerging-emerging economies. It's not so much that growth in these countries is stronger than among the BRIC economies, but that there's good reason to believe that the trajectory is higher rather than lower.
Indonesia's growth slowed to 6.23% in 2012 from 6.5% in 2011. Growth in the core consumer sector remained a strong 5.75%. And the country's central bank has plenty of room to cut interest rates if it needs to prop up growth, with its benchmark rate at a historic low of 5.75%.
Mexico is a direct beneficiary of the strength of the US economy, because the country has been picking up manufacturing business from China due to cost and its proximity to the US market. The World Bank projects growth to drop to 3.5% in 2013, from 3.9% in 2012, but then to recover in 2014 with help from US growth and reforms that will open up Mexico's oil and media sectors to new competition.
The financial direction of these countries is exactly the opposite of that of the BRICS. In the same week that Fitch downgraded China, Standard & Poor's upgraded Colombia to its lowest investment grade, BBB.
In March, Standard & Poor's revised its credit outlook on Mexico, suggesting that the country could get an upgrade from its current BBB rating in the next few months. And also in March, Standard & Poor's upgraded Turkey to BB+ from BB, leaving the country one step below investment grade.
In absolute terms, countries like Mexico and Turkey and Colombia may not have stronger economies than those of Brazil or China (and they're certainly not as big). But in relative terms, they are on an upswing, while the BRIC countries seem like they've run head-on into problems.
Making the Moves
So what do you do as an investor?
First, I think you need to recognize that this sentiment—BRICS no, emerging-emerging yes—won't last forever. All it really needs to turn around is better news from China that would revive dreams of more robust commodity growth. That would give a huge boost to China, Brazil, and Russia at the least.
Second, however, you need to recognize that, at the moment, sentiment is running very strongly toward emerging-emerging markets over the BRICS. A recent survey by The Economist of 700 investors and executives gave first place among markets likely to offer the best returns in the next year to the United States. China, last year's top pick, dropped to No. 2.
Russia took a big tumble to rank behind Japan. Southeast Asian economies as a group took over the No. 3 slot from Brazil. Brazil's percentage ranking in the survey fell to 31% in 2013 from 35% in 2013. India's tumbled to 31% from 48%. Latin America moved up to 21% from 19%.
You should also note that a large percentage of respondents to the survey worried that emerging-emerging markets were getting overheated.
Third, because that fear of overheating is real—and because a slowdown in China will lead to a slowdown in export sectors in all global economies—I'd stick with domestically oriented companies in BRIC and emerging-emerging markets.
That makes your stock-picking task harder, since most of the BRIC and emerging-emerging market stocks we're familiar with are large exporters ,such as Brazil's iron ore giant Vale (VALE). So you have to do some deep digging to come up with domestic emerging-emerging market stocks that you have any shot at buying in New York as ADRs (American Depositary Receipts) that trade with reasonable volume.
5 to Run With
Let me give you five. Four you can buy in New York, and one trades only in local markets, but I think you'll be able to buy it through the international desk at most brokers.
From Mexico, I'd suggest Grupo Televisa (TV), which looks like it has dodged the worst damage in the proposed reform of Mexico's very concentrated media sector.
From Panama, but actually from all of Latin America, I'd suggest Copa (CPA), an airline that flies throughout Central and Latin America and to the United States via a sharing agreement with United Airlines, a subsidiary of United Continental Holdings (UAL).
From Japan, but actually from all over Southeast Asia, I'd suggest Seven & I (SVNDF). The owner of the global 7-Eleven empire, the company has 46,600 stores worldwide, but only 15,600 of those are in Japan.
The company also operates 1,351 stores in Mexico, 6.296 in Thailand, 1,328 in Malaysia, 689 in the Philippines, 57 in Indonesia, and 561 in Singapore. (Note that it trades with better volume in Japan as 3382.JP.)
From Singapore, I'd suggest Singapore Telecommunications (SGAPY). Singapore is in the midst of a huge build-out of its high speed network, and that means lots of new traffic even for incumbents such as Singapore Telecommunications. The stock yields almost 3.7% (and Singapore does not have a withholding tax on dividends for overseas investors).
And finally from Singapore, but really for all of Southeast Asia, I'd suggest the Singapore Stock Exchange, trading there as SGX.SP. Singapore is going to win a share of financial traffic that will move from New York, London, and Tokyo in the next decades. And the city-state does have some significant advantages over Shanghai and Hong Kong that will make this a viable alternative market.
These five picks certainly don't exhaust the emerging-emerging universe. But they should be enough to get you started and suggest directions for your own research.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did own positions in Copa, Grupo Televiso, Seven & I, and Singapore Stock Exchange as of the end of March. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.
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