BRICS SCEPTICS HAVE THEIR BACKS TO THE WALL

BRICS SCEPTICS HAVE THEIR BACKS TO THE WALL
(from Financial Times)

By Steve Johnson
Friday, December 15, 2006

It is exactly five years since Jim O'Neill, head of global economic research at Goldman Sachs coined the term Brics to encapsulate the arrival of the emerging market heavyweights of Brazil, Russia, India and China on the global stage.

Five years on, Mr O'Neill says that not only has the Brics phenomenon exceeded his expectations, but that the dream is likely to continue in the years ahead.

Goldman estimates that the quartet have accounted for 30 per cent of global growth since 2000, with the Brics' share of global GDP rising, in dollar terms, from 7.8 per cent to 11 per cent over the same period.

Further, the Brics states' emerging clout has reverberated around the global economy, nowhere more so than in the commodity markets, where China and India's seemingly insatiable thirst for metals and energy has propelled a multi-year bull run, boosting the economies of exporters such as Russia and Brazil.

Partly as a result, eight years after the Russian debt crisis, Moscow's foreign exchange reserves now stand at $280bn (�10bn, £142bn) - greater than the entire eurozone.

More importantly still for would-be investors, Goldman sees no slackening of this trend in the immediate future, with the US bank pencilling in GDP growth of 8.5 per cent for the Brics in both 2007 and 2008, against little more than 2.5 per cent for developed economies and 4.2 per cent for the world at large.

"We now think the Brics could become bigger than the G6 by 2035," says Mr O'Neill, who sees all of the quartet taking their place in the world's six largest economies by 2050.

It is, of course, unsurprising that Mr O'Neill should be so effusive about his acronymic creation, and there are plenty of other market-watchers who balk at the logic of lumping them together.

Jerome Booth, head of research at Ashmore Investment Management, the emerging market specialist, is particularly critical, labelling Brics a "marketing gimmick".

"I think it is a completely artificial distinction to separate them from other emerging markets, it is not as if there is a strong link between them," he says.

Mr Booth's annoyance with the term is such that he has crafted his own rejoinder; "Cement", Countries in Emerging Markets Excluded by New Terminology, arguing that "if you want to build a wall, you need both bricks and cement".

Nevertheless, he, and many other regional specialists remain confident that strong economic growth in the Brics nations will deliver financial rewards.

Since the start of 2001, Brazilian equities have delivered returns of about 165 per cent in dollar terms, with gains in India (229 per cent), China (348 per cent) and Russia (713 per cent) more astronomical still.

It would be easy to conclude that the juiciest gains have thus been made, but emerging market specialists will have none of it.

Julian Mayo, investment director at Charlemagne Capital, which runs Russian, Indian and Chinese funds, as well as a Latin American offering, argues that the gains have, broadly, not outpaced earnings growth, and valuations thus remain attractive.

"Brazil is on nine times 2007 earnings and China and Russia on 11-12 times. India, at 14, looks expensive at first glance, but it generally has higher earnings growth, 25 per cent this year and 15 per cent next year," he argues.

Mr Mayo attributes much of the earnings growth to the fact that companies, particularly in China, have for the first time concentrated primarily on generating year-on-year profit growth.

While this may sound an obvious business goal to western ears, he argues that companies in countries such as Japan, Korea and China have not always focused primarily on the bottom line.

Brad Aham, head of emerging markets at State Street Global Advisors, accepts that the Brics' discount to developed world markets has narrowed in recent years, so "the margin of safety provided by distressed valuations isn't there anymore".

However, Mr Aham believes the flow of privatisations and IPOs means the index representation of Brics and other emerging markets will continue to grow, sucking in more money, although he argues that countries such as Mexico, South Africa, Turkey, Taiwan and South Korea deserve to share top billing with the Brics.

Mr O'Neill believes this year's rally in Chinese equities could be the start of a bull market, potentially lasting five years or more, although he accepts that India and Russia will struggle to repeat their gains of the past half decade in the next five years.

Brazil has been the laggard in both stock market and economic growth terms, not helped by interest rates that peaked at 19.75 per cent in 2005 and are still a chunky 13.25 per cent.

But Mr Mayo compares this experience with the early days of Thatcherism in the UK or South Korea post 1997; once inflationary expectations are finally squeezed out of the system, the growth backdrop should be more attractive.

Of course, many studies have suggested there is no link between economic growth and stock market performance in a given country, an argument that, to some extent, undermines the Brics logic.

But Mr O'Neill does not buy this. "Over the long term real GDP growth is a very good proxy for long-term earnings growth," he argues. "If you are trying to calculate some sort of equity risk premium, show me something that is more relevant."

Value may be harder to see in Brics' bonds, with spreads over US Treasuries having tumbled from 748 to 219 basis points in Brazil and from 1172 to 112 points in Russia so far this decade.

However, with developed countries such as the US essentially being in hock to the likes of China, Mr O'Neill wonders why even spreads this small should persist. "They are lending money to the US, why should they be charged a premium for the spread?" he asks. "The Brics thing has turned everything upside down."