BRIC Decade Ends as Growth Peaked: Goldman

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By Michael Patterson and Shiyin Chen - Dec 28, 2011 3:35 AM ET

    

In the past decade, mutual funds poured almost $70 billion into Brazil, Russia, India and China, stocks more than quadrupled gains in the Standard & Poor’s 500 Index and the economies grew four times faster than America’s.

Now Goldman Sachs Group Inc. (GS), which coined the term BRIC, says the best is over for the largest emerging markets.
BRIC funds recorded $15 billion of outflows this year as the MSCI BRIC Index sank 24 percent, EPFR Global data show. The gauge, which beat the S&P 500 by 390 percentage points from November 2001 through September 2010, has trailed the measure for five straight quarters, the longest stretch since Goldman Sachs forecast the countries would join the U.S. and Japan as the top economies by 2050.
“In emerging markets, we’re waiting for things to get worse before they get better,” said Michael Shaoul, the chairman of Marketfield Asset Management in New York who predicted in February that developing-nation stocks would fall this year. The $845 million Marketfield Fund (VONEMBI) has topped 97 percent of peers in 2011, data compiled by Bloomberg show.
BRIC indexes may fall another 20 percent next year, buffeted by the liquidity squeeze stemming from Europe’s sovereign debt crisis, Arjuna Mahendran, the Singapore-based head of Asia investment strategy at HSBC Private Bank, which oversees about $499 billion, said in an interview. Nations such as Indonesia, Nigeria and Turkey may overshadow the BRICS in the next five years as they expand from lower levels of growth, he said.

BRICs Slowdown

“The slowdown we’re seeing in the BRICs will continue for most of the first half,” Mahendran said. “Compared to the U.S., corporate profits haven’t been that good as companies face higher wages, higher interest rates and currency volatility, and at best, we’ll only start to see the effects of monetary policy loosening in the second half of 2012.”
Gross domestic product in the four countries rose at the slowest pace in almost two years last quarter and Goldman Sachs said this month that their potential economic growth rates have probably peaked because of a smaller supply of new workers. Even as Brazilian and Russian policy makers start to lower borrowing costs, profit growth in the MSCI index will slow to 5 percent next year from 19 percent in 2011, trailing the S&P 500 by five percentage points, according to more than 12,000 analyst estimates compiled by Bloomberg.
Average economic growth in the BRIC countries will decelerate to 6.1 percent next year from a high of 9.7 percent in 2007, according to September estimates by the International Monetary Fund. That would narrow the gap over America’s expansion to 4.3 percentage points, the smallest since 2004, the IMF data show. Global GDP may increase 4 percent next year, restrained by 1.1 percent growth in the euro area, the Washington-based fund said.

‘Meaningfully Slower’

Slowing exports to Europe and government restrictions on real-estate investment are curbing the expansion in China, the biggest emerging economy. India’s growth has been hampered by the fastest interest-rate increases since 1935 and the rupee’s decline to a record low, which fueled inflation and deterred foreign investment. Brazil and Russia, whose growth during the past decade was spurred by surging commodity demand, have been hurt by falling metals prices and the slowdown in China.
“In emerging markets across the board, all the numbers are pointing toward meaningfully slower growth” next year, Rajiv Jain, who oversees about $15 billion as a money manager at Vontobel Asset Management Inc. in New York, said in a Dec. 5 phone interview.
Jain’s emerging-market equity fund beat 98 percent of peers this year, buoyed by holdings of beverage and tobacco companies whose profits are resilient to economic slowdowns.

2011 Losses

The BSE India Sensitive Index led declines among BRIC equity gauges this year, falling 23 percent. China’s Shanghai Composite Index also dropped 23 percent, while Russia’s Micex retreated 18 percent and Brazil’s Bovespa sank 16 percent. The 21-country MSCI Emerging Markets Index (MXEF) lost 20 percent, while the S&P 500 gained 0.6 percent.
The MSCI BRIC Index slid 0.8 percent as of 8:30 a.m. inLondon and the MSCI Emerging Markets Index dipped 0.6 percent, set for the lowest close in a week. The Shanghai Composite gained 0.2 percent, the Sensex dropped 1.1 percent, while the Micex was little changed.
Egypt’s EGX30 Index (EGX30) tumbled 49 percent this year, the biggest decline in emerging markets, as political turmoil stifled tourism and deterred foreign investment following the popular uprising that ousted President Hosni Mubarak. The Philippine Stock Exchange Index posted this year’s largest gain, advancing 3.2 percent after higher consumer spending countered the global economic slowdown.

Peak Expansions

Longer-term economic growth rates in the BRIC nations are poised to drop as their working-age populations increase more slowly and then eventually shrink, according to a Goldman Sachs report on Dec. 7 titled “The BRICs 10 Years On: Halfway Through The Great Transformation.”
“We have likely seen the peak in potential growth for the BRICs as a group,” Dominic Wilson, an economist at Goldman Sachs, wrote in the report. Wilson made the New York-based firm’s first detailed long-term forecasts for the BRIC nations in 2003, two years after Jim O’Neill, then head of economic research, coined the term.
O’Neill, now chairman of Goldman Sachs’s asset-management unit, declined an interview request for this story. His latest book, “The Growth Map,” talks of “rosy prospects” for the BRICs as well as the potential of the “Next Eleven” most populous emerging economies.

Fund Flows

Goldman Sachs’s bullish outlook for the BRIC nations proved prescient as the economies expanded at an average pace of 6.6 percent during the past decade, more than four times faster than America, according to IMF data. Investors poured about $67 billion into Brazil, Russia, India, China and BRIC mutual funds from 2001 to 2010, data compiled by Cambridge, Massachusetts-based EPFR Global show.
This year’s fund outflows were the biggest on an annual basis since at least 1996, according to EPFR Global. India equity funds recorded about $4 billion of net withdrawals, while China funds lost $3.6 billion. Investors pulled $2.2 billion from Brazil, $326 million from Russia and $5.3 billion from funds that invest in all four of the BRIC countries. All emerging-market funds tracked by EPFR Global had about $47 billion of outflows, leaving assets under management at $605 billion.

Rate Cuts

Large fund outflows are a contrarian indicator because they may signal pessimistic investors have already sold, setting the stage for a trough in share prices, according to Jonathan Garner, the chief Asia and emerging-market strategist at Morgan Stanley in Hong Kong. Emerging-market funds recorded about $48 billion of outflows in the five months ended October 2008, when developing-nation stocks began a rally that sent the MSCI emerging-market index up 108 percent in 12 months.
Emerging-market stocks will probably outperform U.S. equities next year as central banks in developing countries cut interest rates to stimulate economic growth, said James Paulsen, the chief investment strategist at Wells Capital Management in Minneapolis. The MSCI emerging-markets gauge (MXBRIC) rose an average 35 percent after the BRIC nations began cutting interest rates in 2003, 2005 and 2008.
Brazil has reduced its benchmark Selic interest rate by 1.5 percentage points since August to 11 percent. China lowered banks’ reserve requirements in November for the first time since 2008, while forwards contracts in Russia and India show that traders are betting on interest-rate cuts in the next 12 months.
In the U.S., the Federal Reserve has pledged to hold interest rates near zero until at least mid-2013.

Easing Policies

“I like the emerging markets better than anything right now,” Paulsen said in a Dec. 7 interview on Bloomberg Television. “Most of these emerging-market policy officials are turning to easing policies.”
While the MSCI BRIC index has dropped to 8.4 times estimated profit from 13 times at the start of the year, valuations are still higher than they were a decade ago. The MSCI India Index trades for 15 times profit, up from 13 times in 2001, according to data compiled by MSCI Inc.
India’s price-earnings ratios have climbed to an 8 percent premium over U.S. stocks from a 63 percent discount 10 years ago, data compiled by MSCI show. The discount on Chinese shares narrowed to 35 percent from 59 percent, while it shrank to 29 percent from 76 percent in Brazil and dropped to 60 percent from 87 percent in Russia, based on MSCI indexes.

Relative Valuations

Compared to the U.S., valuations for BRIC markets don’t look cheap enough, said Ok Hye Eun, a Seoul-based fund manager at Woori Asset Management Co., which oversees the equivalent of $15 billion.
“BRIC markets won’t be an attractive destination for a while because there are still ongoing risks,” said Ok, citing the prospects of a potential collapse in China’s real estate market and the outlook for economic reforms in India. “I see more opportunities in the U.S.”
ICICI Bank Ltd. (ICICIBC), India’s biggest private lender, trades for 14 times profits, a 42 percent premium over San Francisco-based Wells Fargo & Co., even as analysts predict slower earnings growth at the Mumbai-based bank, according to data compiled by Bloomberg. ICICI Bank profits will increase 10 percent in the current fiscal year, compared with 28 percent at Wells Fargo, the biggest U.S. bank by market value, the estimates show.

Want Want, Redecard

Want Want China Holdings Ltd. (151), a Shanghai-based maker of food and beverages, is valued at 36 times profits and analysts project earnings will increase 7.7 percent this year. The Hong Kong-listed shares are twice as expensive as Northfield, Illinois-based Kraft Foods Inc., which trades for 17 times earnings and may boost profits 13 percent, analyst estimates compiled by Bloomberg show.
Redecard SA (RDCD3), Brazil’s second-biggest card-payment processor, trades for 15 times profits, versus 12 times for New York-based American Express Co. Sao Paulo-based Redecard’s earnings will probably slip 3.8 percent this year while American Express posts a 19 percent gain, analyst projections compiled by Bloomberg show.
Outflows from emerging-market funds may continue next year as economic growth and company results disappoint investors, according to John-Paul Smith, the London-based emerging-market strategist at Deutsche Bank AG. Money managers surveyed by Bank of America Corp. from Dec. 2 to Dec. 8 said their emerging-market holdings are still 23 percent higher than benchmark weightings even after they cut positions from last month.

‘Structural Weaknesses’

“There will be a lot of volatility, but as people realize the underlying structural weaknesses of the BRIC economies, you’ll see money coming out,” Deutsche Bank’s Smith said in a telephone interview on Dec. 19.
China’s economic data have trailed estimates for the past two months, based on Citigroup Inc.’s Economic Surprise Index, a gauge of how much reports are missing economist projections in Bloomberg News surveys. Chinese manufacturing contracted by the most since 2009 in November, while new home prices declined in 49 of 70 cities tracked by the government the same month.
By contrast, U.S. data is beating analyst expectations by the most in nine months, according to the country’s Citigroup surprise index. Manufacturing in America expanded at the fastest pace in five months in November, the Institute for Supply Management said. Initial jobless claims fell to the lowest level since 2008 in the week ended Dec. 10, while U.S. housing starts in November climbed the most in 19 months, government data show.
Per-share earnings in the MSCI BRIC index trailed analysts’estimates by 13 percent last quarter, according to data compiled by Bloomberg. S&P 500 profits beat projections by 4.4 percent, the data show.

Labor Supply

While Goldman Sachs still expects the BRICs to join the U.S. and Japan as the world’s biggest economies by 2050, the bank predicted this month that the four nations’ contribution to the global expansion will diminish during the next few decades. Economic growth in the BRICs may fall to about 4 percent by 2050 as working-age populations dwindle, Goldman Sachs said.
The number of people aged 15 to 64 in Russia has already started to drop, while Chinese workers may peak at around 1 billion and begin falling by 2020, according to estimates by the United Nations. Brazil’s peak may come by 2040, with India’s topping out by 2060, the New York-based United Nations said. The U.S. will keep adding workers through 2100, the forecasts show.
“In the last decade, simply recognizing that the BRICs were the story was largely enough to propel outsized investment returns,” Goldman’s Wilson wrote in this month’s outlook report. “It is much harder to accept that simply believing in their long-term growth dynamics can be a sufficient investment thesis now, if it ever was.”
To contact the reporters on this story: Michael Patterson in London at mpatterson10@bloomberg.net; Shiyin Chen in Singapore at schen37@bloomberg.net.
To contact the editor responsible for this story: Laura Zelenko at lzelenko@bloomberg.net