The 'Brics' are not what they were
Emerging markets once attracted scores of adventurous investors with tantalising opportunities and solid returns. But not any more. The magic's gone, says Merryn Somerset Webb.
Bric: for much of the investment world, this stands for Brazil, Russia, India and China. These were the countries that Goldman Sachs' Jim O'Neill singled out in 2001 as being the biggest and fastest-growing emerging economies and the ones we should all be investing in.
But for Albert Edwards of Socit Gnrale, it stands for something slightly different: Bloody Ridiculous Investment Concept.
Who's right? From 2001 until a few years ago, it rather looked as if it was O'Neill. All of the Brics did brilliantly. Their economies grew at astonishing speeds and their stock markets soared something most people put down to that very growth. In the past few years, however, things haven't gone so well. In 2011, the MSCI Emerging Markets index fell around 20%, and the MSCI Bric index (O'Neill's idea was so embraced that the Brics got their own index!) fell around 25%.
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To me, this makes sense. In 2001, the stock markets of the Bric countries were cheap particularly relative to developed markets. They were also starting to grab the attention of Western investors. I remember writing about the likes of Brazil and China a decade ago, agreeing with O'Neill and encouraging everyone to buy emerging market stocks (and chuck in some commodity funds on top).
Numerous studies have shown that equity market returns aren't correlated to economic growth at all they are correlated to price and money flows. In simple terms, if you buy into markets when they are cheap, you have a good chance of making money and if you buy them when they are not, you have a good chance of losing money. So it was with emerging markets. They were cheap. They went up.
These days, though, it is different. Today, the emerging market index has a price/earnings (p/e) ratio of about 11 times. Developed-market stocks cost much the same. Although the average p/e ratio in the US is 14 times, here in the UK we are on 11; France comes in at 10.3; Germany at 9.7 and even Norway and Sweden are knocking around ten.
Emerging-market bulls will point out that some of the Brics are still cheaper than our markets. China, for example, is on a p/e ratio of around eight times. But I would argue that, for now at least, most emerging market indices should trade at something of a discount to developed market stocks.
Why? Because in a market such as the UK, you can say that the index genuinely reflects private business (not necessarily UK private businesses, but at least companies run roughly according to capitalist principles and to the rule of law). That isn't so much the case in some emerging markets.
According to a report from Hong Kong-based Asianomics, "less than 50 of the approximately 1,400 listed firms on the two Chinese stock exchanges are genuinely privately owned." And those that are properly private tend to be expensive. Those that are not, shouldn't be expensive at all. According to one fund manager cynic, they are run in such a way that they "make the NHS look efficient".
Look at it like this, and I can't see much reason why emerging markets should outperform on the basis of price.
I can't see why they would outperform on the basis of better growth, either. Even if you were to think economic growth rates relevant to stock market returns (which, I repeat, they do not seem to be), it would still be hard to make a case for many emerging markets. China, Asia's driver, seems to be on the edge of a sharp slowdown as its exports to our miserable economies slow, and its property bubble implodes. That, asAlbert Edwards, ever the optimist, put it to me this week "will bring the lot down".
Regular readers will know I have had a bias towards investing in developed-market equities (despite the shocking economies of the countries they are listed in) over emerging-market equities since 2010. I'm sticking with it.
A note on last week's column. In it, I said that a good fund manager needed a mixture of skill and luck (more on luck and momentum in the next few weeks). That riled a few of you I've had many emails asking how I can claim that the excellent records of much-admired managers can possibly be down to anything other than exceptional skill.
Luckily for me, I also got one from a charming Swiss professor: Jrme L. Kreuser of the RisKontrol Group. He attached a 1997 paper written by some of his colleagues, Lester Seigel and Ramasastry Ambarish. It attempts to quantify just how long it takes to distinguish manager skill from manager luck in the equity markets. The answer? Around 175 years. That's a time period that rules out even Warren Buffett.
If Kreuser is right, it seems that we will never know for sure if everyone's favourite value investor is amazingly skilled or just the luckiest man on earth.
This article was first published in the Financial Times.
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