Many BlackRock fund managers have raised their emerging market (EM) allocations lately, and we’ve warmed up in general to the asset class after a long underweight.
EM valuations overall, as measured by the MSCI Emerging Markets Index, look cheap, and we see value for long-term investors. A Fed on hold and weaker dollar are good news for the asset class (see the chart below), and there are signs of progress on structural reforms in certain EM countries.
You may be wondering, however, what we think of the so-called BRIC countries in particular—otherwise known as Brazil, Russia, India and China—especially given the recent political-scandal and slowing-growth headlines surrounding some of these countries. Despite the economic and political challenges facing these one-time darlings of the EM world, we still see long-term opportunities within the BRIC universe.
We like Brazil
The words impeachment, corruption, bribery and recession are all too synonymous with Brazil these days. And perhaps with justification, Brazilian gross domestic product (GDP), on the decline since 2010, finally entered negative territory in 2015 at -3.0 percent. Economists expect to again see negative economic activity in Brazil this year, with growth at -3.4 percent, according to Bloomberg data. Local inflation remains high, forcing the Brazilian central bank to leave its policy rate unchanged since July 2015.
With so much bad news emanating from Brazil, one might ask what’s there to like about this BRIC? We believe Brazil offers value, as there’s potential for a significant turnaround story. Much of the bad news about Brazil appears already priced into the market. Brazilian equities, as measured by the MSCI Brazil Index, are 20 percent cheaper than their 2014 highs on a price to book basis. This means we could see Brazilian stocks move higher if confidence in the market is restored.
We think sentiment toward Brazil has just begun to turn, as many long-term investors remain on the sidelines. In addition, lower real wages and declining labor costs are making the country more attractive for foreign business when measured against regional Latin American peers. However, an investor confidence recovery ultimately will rest on whether we’ll see real political change and reforms.
We’re neutral toward Russia
Undoubtedly, Russia is the BRIC member with the most to gain from recovering oil prices. Russia reaped the benefits of the oil price boom starting in the early 2000s, averaging 7.1 percent GDP for the six years ending in 2008. Last year, oil revenue accounted for 45 percent of Russian government revenue, according to an analysis of data accessible via Bloomberg. But Russia’s economy has suffered more recently, following declining oil prices and economic sanctions imposed by the U.S. and eurozone. The country entered a recession in 2015 and is expected to produce negative growth again in 2016, based on consensus forecasts available via Bloomberg.
A flexible currency has allowed Russia to quickly adjust to economic difficulties, and Russian markets are receiving inflows following rebounding oil prices. However, we need to see sustained economic momentum and a more sustainable long-term economic growth model not so dependent on oil. Thus, in the context of an EM portfolio, we advocate remaining neutral this BRIC.
We favor India
India is a bright spot within the BRICs and stands out in a world where economic growth is sparse. In 2014 and 2015, the country expanded at 6.9 percent and 7.3 percent, respectively. According to the IMF, India’s 2016 GDP is forecasted to grow at 7.5 percent.
Yet even with this rosy economic picture, India’s market performance has waned since reaching a post crisis peak in January 2015, weighed down by a rising U.S. dollar and slow progress on fiscal reforms. Looking forward, we are encouraged that the Indian government has committed to keeping the fiscal deficit in check. Furthermore, the government is expected to spend 0.3 percent of GDP on public infrastructure that should support growth. As such, we’re likely to see fiscal and monetary policy makers working in unison to spur growth. This, combined with a reasonable valuation for the S&P BSE Sensex Index, bodes well for Indian stocks into 2017.
We like China
Sentiment toward China began deteriorating in August of 2015, with the domestic stock market crash and less transparent currency management. Long-term issues remain, and the country’s reforms have slowed due to cyclical pressures.
However, the reforms that have been implemented are ones that are supportive to growth. In addition, the Fed’s delay has eased pressure on China, and we’re encouraged by the slowing of capital outflows from the country. Finally, Chinese stocks (measured by the Shanghai Stock Exchange Composite Index) have trailed their Brazilian counterparts (measured by the Ibovespa Index) and moved in lock step with Russian equities (represented by the MICEX Index) since late January, based on Bloomberg data, and their low valuations are poised to potentially rise in a risk-on environment.
Looking forward, we could see Chinese multiples increase as investors regain confidence in the country’s outlook. Within China, we prefer the offshore market vs. the domestic market, as well as domestic sectors and companies that could benefit from expected Chinese structural reform.
The main takeaway from all of this: Investors should be cognizant that EM is no longer a homogenous asset class, and each market faces its own challenges. Even within the BRICs, there is growing heterogeneity across countries.