Are BRICs Dead Or The Ultimate Contrarian Play?

The BRIC phenomenon quickly became a Wall Street buzzword in 2001 when former Goldman Sachs economist Jim O’Neill argued the four countries Brazil, Russia, India and China would be emerging heavyweights.

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Shares of BRICs (South Africa was inducted in 2010) funds bounced back from the Great Recession on high commodity prices but have lagged the S&P 500 over the last five years. An equal-weighted portfolio of the emerging market behemoths would have yielded an annualized 3.3% return versus 11.5% for the large cap U.S. index.

#-ad_banner-#No longer the hot momentum trade, is it time to lay the emerging markets giants to rest or time to play contrarian and snap up some great deals?

Emerging Markets: Near-Term Pain But Long-Term Gain
The BRICs and the entire emerging markets theme aren’t without problems. From economic to geopolitical hurdles, 2018 is shaping up to be a year of pain for the group.

China has escalated its trade war with the United States as both sides look to impose tariffs now on $50 billion in goods, a number that could rise even further if President Trump moves ahead with threats to tariff $200 billion in Chinese imports.

Russia has been under international sanctions since 2014 for its annexation of Crimea and involvement in Ukraine, as well as its continued meddling in foreign elections. The Russian rouble recovered on higher oil prices for most of last year but has depreciated by more than 20% this year on new sanctions.

Brazil has faced an unending spotlight of endemic corruption with trials that have already brought down former President Rousseff and threaten current President Temer. The upside to the investigations is that they seem to have highlighted a new independence in the judiciary.

India remains the only BRIC nation not facing major issues. Prime Minister Modi’s administration hasn’t been without its problems but none have threatened it on an existential level or been able to slow growth, which is among the fastest in the region.

Most recently, weighing on the entire emerging market theme has been the currency collapse in Turkey and fears of cross-border contagion. The rising greenback this year has brought weaker EM currencies, pressure on central banks to raise rates and the threat of slower growth.

Against the glaring geopolitical and economic issues facing the group, it’s hard to deny their place on the global economic stage and potential for the future.

The group of four accounts for 24% of global GDP and is growing at rates up to two and a half times that of the United States. The BRIC countries also account for nearly 40% of the world’s population, a huge tailwind as their economies shift to consumer-driven growth. The middle class in China and India alone are expected to grow by 730 million by 2030, more than twice the entire U.S. population.

The rise in the value of the U.S. dollar that is threatening financial accounts across the EM space is likely short-term against growing deficit spending and an economy that doesn’t look able to sustain recent GDP growth. The dollar plunged nearly 8% last year against a basket of currencies, contributing to strong gains in BRIC investments, and could become a tailwind again very soon.

Banking On The BRICs
Investing in the BRIC indices is certainly a contrarian play and could be for the rest of 2018, but long-term demographic and economic forces should push them higher.

Russia may continue to be the laggard as the government seems bent on denying any foreign interference yet continuing to commit the kind of acts that bring new sanctions. China is as obstinate in fighting an escalating trade war but has enough economic bargaining power that it should be able to negotiate for long-term gain.

iShares MSCI Brazil (NYSE: EWZ) has seen shares tumble by 14.3% so far this year and trades for 15.7 times trailing earnings of the companies in the fund. The country accounts for 2.5% of global GDP, according to the International Monetary Fund (IMF). Brazil may benefit from the U.S.-China trade war as the Chinese look to other agricultural producers. The country holds a general election for president and congress in October which could help to reset some of the image problems it’s been fighting lately.

The corruption scandals do not appear to be weakening growth. Earnings for the index jumped 22.5% last year and are expected to post even better this year with a 24% rise in corporate profitability, according to Yardeni Research. Growth in 2019 is expected to come down but still post a modest 14.6% increase.

iShares MSCI Russia (NYSE: ERUS) has seen shares drop just 4.2% this year and now trades for 7.5 times trailing earnings. Earnings for the index of Russian companies grew 11.8% last year and are expected to jump 27% this year before plunging to an increase of just 2.5% in 2019.

Despite crippling economic sanctions, the government remains committed to a political agenda at the expense of its people and economic growth. Rebounding oil prices have kept the country from collapse but the one-time powerhouse now accounts for just 1.9% of global GDP. Of the BRICs, Russia is the only country I would avoid until the regime changes or proves it would put growth above political gain.

iShares MSCI India (NYSE: INDA) is the standout among the group with a loss of just 0.72% this year but is trading for a relatively expensive 21.4 times trailing earnings. Last year may be a trough for earnings with a decline of 0.7% per share.

Earnings are expected to surge 26.3% this year and 20.5% in 2019. Accounting for 3.3% of global GDP but growing at the fastest rate among the BRICs, India may be the most shielded from the developing trade war for its focus on service exports rather than goods.

iShares MSCI China (NYSE: MCHI) has fallen 8.9% so far this year and trades for 12.7 times earnings. Index earnings exploded last year by 25.4% and are expected to post 17% growth this year and 16% in 2019.

With economic growth of around 6% annually, the world’s second largest economy adds nearly $800 billion in economic might to its base. The middle class in china are becoming a force in global consumer spending, growing to 15% of the global cohort in 2015 and adding over 850 million to the list in the two decades to 2030, according to the OECD.

Risks To Consider: The trade war with China and Russia’s economic problems are likely to get worse before they get better. Investors need to take a long-term view on growth in these regions.

Action To Take: Take advantage of the BRICs’ fall from grace to make long-term, diversified investments in regions that make up 24% of the global economy.

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