Forget the BRICs; Here's a Better Way to Think About Emerging Markets
It has been a decade since Goldman Sachs economist Jim O'Neill coined the acronym "BRIC" (Brazil-Russia-India-China) as a handy shorthand term for emerging-market economies that were likely to experience above-average growth in the process of converting from predominantly rural, agrarian living to more urban, industrial modes. Since then, there have been giddyups (Brazil's stock market up 97% in 2003) and downs (Russia's bourse down 72% in 2008), but overall, the trend line for the first decade of the 21st century pretty much played out the way O'Neill expected: outsized growth among the BRICs.
Of late -- the past couple of years -- the BRIC's stock indices have generally just matched or even underperformed the U.S. market, but investors who place their bets in accord with macro economic, political, and social trends are mostly still comfortable with the proposition that the BRICs are likely to continue to outperform in terms of GDP growth at least between now and 2020 ... and probably beyond. Not that faster GDP growth necessarily guarantees superior market performance. But all things being equal, it's a valuable advantage to have.
With that in mind, let's look at market performance through the first decade of the 21st century. Here's the annualized performance of the leading stock market index for each of 16 selected nations:
This being an exercise in investment analysis, we've only included indices for which at least one index-tracking exchange-traded fund with a market cap of $1 billion or greater and average daily volume of 1 million shares or more is available to U.S.-based investors. (There have been some outstanding performances from more thinly capitalized and traded national ETFs, but being less liquid, those generally constitute more risky investment vehicles subject to larger valuation swings in times of high volatility, so I excluded them. Besides, we were running out of colors on our chart.)
And the winners are ...
What this chart tells you is that if you had invested $10,000 in the Russian stock market -- diversified to match the composition of the RTSI (which is to say, weighted in favor of energy and raw-materials companies) -- at the close on Dec. 29, 2000, by Dec. 30, 2010 ,you would have had $123,544, which amounts to a return on investment of 1,135% (the 1,235% on the chart minus the 100% of your investment you began with). This is equivalent to a decade-long compounded annual growth rate (CAGR) of 29%. Sure beats the average hedge fund!
In the second tier, the indices of Mexico and India had around 20% CAGRs, and Brazil and South Korea were around 15%.
In the next tier -- CAGR of 5% to 8% -- were the stock markets of Malaysia, Taiwan, and Singapore, respectively.
The fourth tier was composed of four markets that turned in CAGRs of around 4%: Hong Kong, Canada, Australia, and China.
Finally, bringing up the rear were four essentially flat-to-negative indices: Germany, the USA, the U.K., and Japan. Here's a rundown of all the markets in our chart along with the pertinent ETF or ETN:
|Russia||RTSI||RTS.RS||Market Vectors Russia||(NYS: RSX)|
|Mexico||SE IPC||^MXX||MSCI Mexico Index||(NYS: EWW)|
|India||BSE SENSEX||^BSESN||India Earnings||(NYS: EPI)|
|Brazil||IBOVESPA||^BVSP||MSCI Brazil Index||(NYS: EWZ)|
|South Korea||KOSPI Composite||^KS11||MSCI South Korea Index||(NYS: EWY)|
|Malaysia||Bursa Malaysia||^KLSE||MSCI Malaysia Index||(NYS: EWM)|
|Taiwan||Taiwan Capitalization Weighted Stock||TAIEX||MSCI Taiwan Index||(NYS: EWT)|
|Singapore||Straits Times||^STI||MSCI Singapore Index||(NYS: EWS)|
|Hong Kong||Hang Seng||^HIS||MSCI Hong Kong Index||(NYS: EWH)|
|Canada||S&P/TSX Composite||^GSPTSE||MSCI Canada Index||(NYS: EWC)|
|Australia||S&P/ASX 200||^AXJO||MSCI Australia Index||(NYS: EWA)|
|China||Shanghai Composite||000001.SS||FTSE China 25 Index||(NYS: FXI)|
|Germany||DAX||^GDAXI||MSCI Germany Index||(NYS: EWG)|
|USA||S&P 500||^GSPC||SPDR S&P 500||(NYS: SPY)|
|U.K.||FTSE 100||^FTSE||MSCI United Kingdom Index||(NYS: EWU)|
|Japan||NIKKEI 225||^N225||MSCI Japan Index||(NYS: EWJ)|
When you look at the original BRICs, the one that stands out as being most unlike the other three is Russia. Russia was a way more developed country in 2000 than China or India in terms of per-capita GDP, income, urbanization, telephones, transportation, and so on ... and was generally ahead of Brazil in most of these categories.
When you are looking for growth, being further ahead in terms of development is not a plus, because it implies that future growth will be moderate. Additionally, Russia was one of the few nations in 2000 with a declining population -- also bad for growth. You'd expect these factors to inhibit market performance -- and many people criticized O'Neill's decision to include Russia among the BRICs -- but in fact the combination of its focus on the energy sector -- which was hot because of galloping Chindia demand -- and the fact that its market was beaten down in the '90s with all the travails and uncertainty following the demise of the USSR propelled it to the top of the heap for the decade. Pretty good performance for a country where a multibillion-dollar public company like Yukos can be arbitrarily destroyed by the government. Actually, it's instructive that while in the wake of the 2003 Yukos incident, appreciation in the value of the RTSI slowed down for a year, the financial-meltdown-related drop in the price of oil in 2008 crashed the RTSI! Clearly (1) the market considers energy demand to be a much more significant factor for Russian valuations than government interference, and (2) because of the RTSI's energy concentration -- and the price of oil fell from $145/barrel to $32/barrel in six months in 2008 -- it is by far the most volatile of the BRICs indices.
Of course, when you look at our chart, the BRIC that's the biggest contrast to the others is China ... and the comparison is not favorable. At just a 3% CAGR, the Shanghai Composite's decade looks much more like the (non)performance of the S&P 500 than the buoyant curves generated by the RTSI, SE IPC, or BSE SENSEX. There is a good reason for this dissonance, and it has nothing to do with China's underlying growth rate, which remained strong. China's market index includes heavy weightings for many huge, formerly state-owned -- and still partially state-owned, in most cases -- enterprises that have frequently found the transition to free-market competition challenging.
Top-line growth has generally kept pace, but sufficient quantities of black ink have been lacking. Many of these enterprises are debt-laden, and it's unclear how many of them will ultimately survive. In the long run, the performance of the successful companies will improve, and the relative weight of the laggards will decline as they fall by the wayside and are supplanted by more competitive enterprises. In the meantime, the performance of the Shanghai Composite is likely to continue to reflect China's growth less effectively than, say the Hang Seng (although the same issues are reflected there to some extent) or even the Taiwan index. Generally speaking, Chinese index ETFs have not been as effective investment vehicles for transporting their economy's underlying growth into your portfolio as the other BRIC index ETFs.
So ... what's next?
Of course, as the venerable shibboleth goes, "past performance is no guarantee of future returns." How will the BRICs stock markets fare over the next 10 years?
As I mentioned, there's not much debate among macro-analysts as to the continued robust validity of O'Neill's basic insight. It would take a lollapalooza of a black swan to dissipate the inertia of the BRICs -- something on the order of an epidemic or a catastrophic natural disaster that killed many millions. So, in that light, the pertinent question is not where the BRICs bus is headed, but rather, who is going along for the ride.
The BRICs themselves -- which began acting as a formal group in 2009 -- officially added South Africa to their number late last year. So they now call themselves the "BRICS." There is some debate about the proper plural form: BRICSs? Fortunately, the small size of the South African economy consigns it to stowaway status at best in the minds of most macro analysts, so we pretty much ignore that nomenclature issue.
O'Neill himself has at various times endorsed South Korea, Mexico, Turkey, and Indonesia as potential bus passengers. I like that thinking, and for now, I'm going to go with the first two, for three reasons:
- They are the next two largest economies after the original BRICs (technically after Russia-Brazil-India, as China is already No. 2 in the world).
- They are both in the top five on our performance chart along with Russia-India-Brazil.
- There are funds that track their stock markets that meet our criteria (available to U.S.-based investors with a market cap of $1 billion or greater and average daily volume of 1 million shares or more).
Thus: China-Russia-Brazil-India-South Korea-Mexico. Or McRIBS for short. It's a small "c" because effectively investing in the China growth story is more complicated than just buying an ETF that tracks their stock market. And, of course, because it makes for a cooler acronym.
At the time this article was published Guest contributor Brad Hessel currently owns shares of iShares MSCI Brazil Index Fund (EWZ), iShares FTSE China 25 Index Fund, the India Fund (IFN), and ProShares SHORT S&P 500 (SH, which, though not mentioned in the article, effectively makes him short the S&P 500 ETF, SPY) and has no position in any of the other equities mentioned; however, Brad's clients may have such positions. The Fool's disclosure policy includes certain trading restrictions that apply to Brad. However, his clients are not subject to our disclosure policy and thus are free to trade any such equities.
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