GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Why I Am Bearish on The BRICs

Nowadays, many people seem to be bullish on the BRICs( Brazil, Russia, India, China). The bulls expect these countries to experience rapid growth in the future and therefore argue that their equities should be purchased. But how much growth can we expect, and what is the macro picture like in these countries? Let us examine each country one by one.

Brazil: The country experienced a massive economic crisis only eleven years ago. Has so much changed then, and is this time different? Bulls will argue that Brazil is the eighth largest economy in the world, but it was also the eighth largest economy in 1999 when it devalued its currency.

There are also signs the economy is overheating. Brown Brothers Harriman’s Win Thin wrote recently:

Some of the numbers are deteriorating sharply for Brazil, including the external accounts, and should help limit BRL upside. Exports remain robust, but imports are going through the roof and leading to worsening trade and current account balances. June current account gap was reported at a much higher than expected -$5.2 bln, and pushed the 12-month total to -$40.9 bln or -2.1% of GDP, the highest since Oct. 2002. FDI flows have held up OK, but now only covers less than two thirds of the current account gap.

Russia: To state Russia has massive demographic problems would be an understatement. The population peaked in 1991 and has been declining ever since. The UN expects the population of Russia to decline as much as a third by 2050. In addition, Muslims are a growing percentage of the Russian population this will likely cause increasing social tensions with the mostly Orthodox Christian population. Russia is run by corrupt politicians and robber barons, and there are poor protections for investors rights. Russia also had its own economic crisis in 1998, when it defaulted on its debt. Now the Government is even more authoritarian and there is no way to predict if the Government would just default as it did in the past.

India: Faces massive problems from the Maoist insurgency in the East. The insurgency has been going on for decades, and the intensity has only been increasing recently. Below is a map which shows how a large swath of the country is affected by this conflict. In the west, India has constant problems with its arch enemy Pakistan. The countries have fought several wars, in addition to many near wars. However, now both countries have large nuclear stockpiles and a war would be an utter disaster for both countries. Any future terrorist attack, or inadvertent border skrimish, has the potential to lead to an all out nuclear war.

india-map-more-than-89-naxalite-maoist-i

China: Has similiar problems with Russia in regards to corrupt Government officials. The whole rural inner area of the country is poor and many people are migrating to the richer coastal region. The economy is entirely reliant on shipping low quality products at low prices to America. However, China is now in competition with other countries that are producing similar goods at low costs and shipping them off to the west. China is fighting an Islamic insurgency near the Mongolian border. There is huge civil unrest in the country, with massive riots and recent suicides among disgruntled workers. China has been manipulating its currency in order to help its export driven economy. Recently, the Government allowed the yuan to float, but do not expect much change to the currency manipulation.

Finally there is the problem of the housing bubble in China. Kennth Rogoff, Robert Shiller, Jim Chanos and other great minds have all stated that China is experiencing a bubble. While it is hard to get exact statistics on the Chinese economy, here is one frightening statistics: Housing property value/ annual disposable income NATIONWIDE is at 8, while the number was at nine in Tokyo at the height of the Japanese bubble. This dispells the argument among China bulls that there might be a housing bubble in cities like Shanghai, and Bejing, but it is not a nationwide problem.

How about valuations? Do these countries have low valuations that would justify investment even with all the macro problems?

Brazil: EWZ ETF PE 14

Russia: RSX ETF PE 10

India: EPI ETF PE 14

China: FXI ETF PE 14

While the valuations seem to be fair, most of the bull BRIC investors seem to be relying on future growth. If one is investing based on the rapid growth of these economies, one must be prepared to assume huge macro risks.

Disclosure: None

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


Rating: 2.2/5 (42 votes)

Comments

superguru
Superguru - 4 years ago


At this point, waiting for a pullback before investing in India seems prudent.

But ignoring these emerging economies is not a very good idea.

These emerging economies are fast growers. US and developed economies are like stalwarts, applying Peter Lynch's terminology to countries.

I plan to have good mix of both.

IMO, As always, price at which one buy determines one's returns.

Adib Motiwala
Adib Motiwala - 4 years ago
Jacob,

What is the source of the map you presented of India and can you elaborate on the 'massive problems' they face? The last war was in 1999 and it was a proxy war fought by Pakistan backed insurgents and India in the Northern state of Kashmir. The effect of this was on Indian economy was neglible and India has only gone from strength to strength since 1990. Pakistan on the other hand is a different story. I think both countries know better than to attack each other using nuclear power

One thing I can tell you is that the index of any of these companies could be fairly valued. However, there are so many small caps and mid caps that are under followed that would be good investments. BSE is the oldest stock exchange in Asia with 5000 companies listed.

India is a democracy has a vast middle class that is growing and getting affluent. The population is highly educated and its a service economy. Some of the things that hold India back is corruption, lack of quality infrastructure at the level of the West and the high population. Despite this the country is growing well. There is tremendous opportunities for investment in infrastructure.

Also, you should look at how the low debt and budget deficit of these countries. People in India ( also China) are net savers. People are used to buying appliances with cash. The mentality is to be conservative savers.

Since international investors tend to move in and out of these markets, there has been volatility in the markets. But, would you say the US markets are any less volatile since 2008? People keep referring to these countries as third world countries. I think its time to move on from that description. Countries such as India that are fiscally disciplined, growing young population, excellent education, and people who are net savers are going to be better places to invest.

Disclosure: Born and brought up in India. Bullish on India.

Sivaram
Sivaram - 4 years ago


I concur with your views Jacob. I have been bearish on BRICs strictly from a contrarian point of view but the macro risks are very real and, as always seems to be the case, ignored by the market until it hits everyone in the face.

The only country that is anywhere near attractive (from a macro point of view; not necessarily from a valuation point of view) is Brazil. I don't like it as much because it is cyclical but its geopolitcal risks, fiscal situation, economic structure, and social structure are better off than Russia, China, or India.

Having said all that, the risk with ignoring these markets is that you may miss out on one of the biggest growth stories of our life. But, as far as I'm concerned, it's ok to miss those stories if getting burned is a real risk.
Sivaram
Sivaram - 4 years ago
IT CONSULTANT: "Countries such as India that are fiscally disciplined, growing young population, excellent education, and people who are net savers are going to be better places to invest."

I don't know much about India and haven't checked lately but India has been running a current account deficit for quite a while. It has also been running big budget deficits and has a relatively high debt (for a developing country.) Apart from political risks, I would say this is the biggest risk for India.
rnagarajan
Rnagarajan - 4 years ago
I first visited India when I set up an engineering office there in 2007 and I returned again about six months later in 2008. The country has some great advantages but also suffers from numerous problems, particularly related to infrastructure. Growth has been so rapid in many areas that roads, airports, and other public infrastructure is in short supply. Even good quality hotels are in short supply which makes prices rival the rates one would pay in major Western cities. You have a group of highly educated workers, but they are in short supply and the educational system for much of society remains subpar. Inflation is very high and businesses employing technical workers must regularly boost pay by substantial amounts or face massive turnover.

Despite all of the problems, the dynamic business environment is unlike anything I've seen in the United States or other developed countries. I think the country has a bright future, but can one translate this into investment success? That's quite a different question, particularly for the typical western investor who isn't familiar with Indian culture, business practices, etc. I have stayed away from investing in Indian securities, although there are many Indian value investors out there. I recall an interview on the Simoleon Sense blog a while back with an Indian investor. I can't find a link right now b/c I'm getting errors on that site - but will post it tomorrow if I remember to.
rnagarajan
Rnagarajan - 4 years ago
Here's the Indian value investor interview from Simoleon Sense. His name is

Chetan Parikh

http://bit.ly/20Gnmw

yswolinsky
Yswolinsky - 4 years ago
IT

I found the map on the internet. I found similar maps that show the same picture I think I found a similar map in The Economist. You can see that the problems cover large parts of Western India.

The tensions between India and Pakistan are no joke. They almost went to war after the Mumbai attacks. There is also the real possibility of the Taliban overthrowing the Pakistani Government and creating an even more volatile situation.

I never said that India does not have positive aspects to it. Almost everyone from India I have met is very hard working,entrepreneurial, and smart. I was just commenting on the macro risks facing the country. And I never said the country was backwards, or anything of the sort.

http://www.valuewalk.com/
Adib Motiwala
Adib Motiwala - 4 years ago
Jacob.

The map shows problem areas in the East and your last post said it was the west. Maybe you meant East? I am not sure of the authenticity of the information shown on the map. I can bet the person who is presenting this has never even visited India.

I agree the situation is always shown as 'tense' in the media between the two countries. However, they were not close to a war after the Bombay attacks.

Every country or company has some kind of macro risks and macro positives. That does not make it a better or worse investment by itself. You have to look at the positives and the negatives. I see so many negatives in the US right now. Debt is almost 100% of GDP ($14 trillion) and growing very fast . Budget deficit is 10% of GDP. We have a trade deficit from many years. The debt does not account for liabilities of Fannie Mae and Freddie Mac. What about the Social security and Medicare costs and ability to service them..... . Population getting older.... Healthcare costs....

Europe supposedly is on the brink of disaster. PIIGS....

Japan's debt is almost 200% of GDP.!!

However, US presents a great place to invest. Hard working people. Innovation . Great companies. etc...

Similarly, India has its share of issues. Problems present opportunities for companies to invest and make money for their shareholders. If you want to invest in India or BRIC using at ETF, maybe the index is fairly valued at this point. However, there are many pockets of cheapness and more than in the US because so many companies are not followed. You have 5000 companies in India. Can you imagine how much inefficiency in information exists there.

I know you are presenting the macro risks facing the country. however you harped only on the negatives and I think it was not a fair balanced view. I could argue that Israel is in the most dangerous place in the world with enemies who want to destroy them. Does it mean Israel or a company from Israel is not a good place to invest? I dont think so.

rnagarajan
Rnagarajan - 4 years ago
India faces a serious test with the Naxalite problem, but this is in part a symptom of the social problems facing the country as development accelerates and not necessarily unlike problems facing parts of China. The difference is that China's authoritarian system can crush these problems in the short run while India's more democratic system cannot. But in the long run, I think the democratic system has an edge.

Although I was aware of extreme poverty in India prior to my first visit, I don't think anything can prepare you for the slums. It hits you right when you land and there is no escape from it even if you are moving from the airport to a high end hotel to modern office complexes. The American image of the typical Indian as a highly educated software developer or a call center worker is anything but reality for the vast majority. And although I've never been to a small village, I'm sure the poverty there makes the urban slums seem great in comparison (or the poor wouldn't migrate to the city).

Yet even in the slums, there are signs of material progress. In parts of Bombay, you can drive by slums that are nothing more than shacks. But many seem to have electricity (although probably stolen given the looks of the power lines), and I could see at least a few televisions lighting up the rooms. I didn't see many bicycles - nearly all Indians seem to move around on motorcycles. More Indians are making it into the middle class.

There is little doubt that India will be a richer country in 10 to 20 years with a larger middle class (assuming that a calamity like nuclear war does not intervene). What is needed is massive investment in infrastructure and education. Indians know how to educate the elite but do a poor job with everyone else - that has to change to stem the social unrest.

LwC
LwC - 4 years ago
rnagarajan, Regarding your remarks about the poverty in India: "It hits you right when you land…"

Although it has been almost 40 years since my first trip into India, I still hold the mental images of the people living in large diameter concrete sewer pipe with what looked like gunny sacks hanging over the ends and other jury-rigged shelters, literally lining the sides of the main runway at the Bombay airport, and with kids playing along the runway. Clearly I wasn't in Kansas anymore.

During one of many trips into China during the nineties, in the Chinese countryside I saw people living in "caves" carved out of the side of hills and fronted with wooden facades that usually had a window and a door.

rgosalia
Rgosalia - 4 years ago
My main issue with the value investing in India is the lack of good quality disclosures and the lack of confidence in the integrity of the markets for smaller stocks. I acknowledge that I could be wrong, since I have often heard arguments about the enormous inefficiency in the small and mid-cap companies that are less followed. Above, itconsultant said:

"However, there are many pockets of cheapness and more than in the US because so many companies are not followed. You have 5000 companies in India. Can you imagine how much inefficiency in information exists there."

The thing that makes me most uncomfortable about the smaller stocks in India is how easy it is to manipulate them. I came across many businessmen (my father being a businessman helped) that ran public companies involving themselves in questionable practices that in the US would be considered in the grey area or outright illegal (having "operators" manipulate the market for their company's stock for them to take advantage of)

It would make an interesting post for someone who is familiar with India and knows about these "pockets of inefficiency" to post a specific idea detailing their investment thesis.

Until I see this, I will continue to be skeptical. I have spent many hours, and found nothing that I could get comfortable with. But, as I said, I may be wrong and I don't mind changing my mind if I am proven wrong.

rnagarajan
Rnagarajan - 4 years ago
"It would make an interesting post for someone who is familiar with India and knows about these "pockets of inefficiency" to post a specific idea detailing their investment thesis."

Right - it's almost like you need to take a page from Jim Rogers and spend a few years in India traveling around on a motorcycle. If you survive the traffic :) and gain some insights, then maybe investing in some unknown companies would be a reasonable thing to do.

As a guy born in the US but with Indian ancestry, I can say that going there was still about as foreign of an experience imaginable ... and I have the advantage of at least being somewhat familiar with Indian culture. I am very far from considering India to be within my circle of competence ...

Adib Motiwala
Adib Motiwala - 4 years ago
Lot of posts here. I am highlighting some of the points made in Italics by others and my replies. I am just trying to present the other side of the story to all the bearish, negative views posted here. I am aware of some of these problems and I recognize them. They will not go away any time soon. However, none of these are reasons for investing or not investing in the country.

I agree with the view that if you have no expertise in India, then you should not invest in individual stocks. You can invest via an ETF. And if you feel the market is fairly valued, then not investing is a wise thing to do. The long term GDP growth and wealth creation story of India is very much intact and in play right now.

Please check the last 5 year and 10 year chart of the BSE and compare that to the SP 500 and you will see the story for yourself. If you take it back 20 years, it might show that the index is up 18x.

See here http://www.rediff.com/money/2007/jul/06bspec.htm

1990: BSE was at 1000.

Today: BSE is close to 18,000

Hows 18x on an index in 20 years!!!

rnagarajan wrote

"Although I was aware of extreme poverty in India prior to my first visit, I don't think anything can prepare you for the slums."I agree there is extreme poverty with a larger % of population when compared to the US. Wealth is never equally shared in any country. I am sure there is a large population in the US that makes bare minimum wages but they are not seen in slums in the US. However, how is the poverty level or disparity related to the investment thesis of a country? How about the middle class and how much it has progressed in terms of income levels and spending power. I think I had heard a quote that if Coke could sell 1 extra coke to every Indian then they would not have to worry about selling to most of the world!

The American image of the typical Indian as a highly educated software developer or a call center worker[/i]

I would argue that most of the world sees India as the land of elephants, cows on the road and snake charmers. Clearly, India is much more than that. India is a large diverse country with a very large population that is getting wealthier. They aspire to use international branded products and have a high quality of life. As you rightly said, even in the slums, you will see color televisions.

Rgosalia wrote

[i]"My main issue with the value investing in India is the lack of good quality disclosures and the lack of confidence in the integrity of the markets for smaller stocks."


Can you give some examples of the above?

"During one of many trips into China during the nineties, in the Chinese countryside I saw people living in "caves" carved out of the side of hills and fronted with wooden facades that usually had a window and a door."I see this as an opportunity. They can hopefully get richer and better off.

[/i]

[i]The thing that makes me most uncomfortable about the smaller stocks in India is how easy it is to manipulate them. I came across many businessmen (my father being a businessman helped) that ran public companies involving themselves in questionable practices that in the US would be considered in the grey area or outright illegal (having "operators" manipulate the market for their company's stock for them to take advantage of)


Are you telling me there is no market manipulation in the US. How about the flash crash? How about the volume / quant / algorithmic trading ? I would argue the US markets as volatile as any market in the world now. And volatility is not risk. There has been enough fraud uncovered in the US in the last several years ( Enron, WorldCom, Tyson, Bernie Madoff, Stanford, how about the derivatives, credit ratings on the financial instruments that no one knew what was in them..........should I go on ??)

If any one is interested in some of the big large caps that are listed in the US as ADRs, I can post an article here on them.

rgosalia
Rgosalia - 4 years ago
itconsultant,

I was not referring to the volatility in India in my original post. You are right - as a value investor, volatility is not really a concern.

I was referring to market manipulation in India in terms of financial frauds. Again, you are right that there have been frauds in the US. But, in the case of Enron and WorldCom, as a value investor reading their 10Ks, you may not have detected fraud but you could have easily stayed away. All one had to do was read their 10Ks and you would have seen enough red flags (not of fraud but of disclosures that would have made value investors uncomfortable). If you have read 'Financial Shenanigans' by Howard Schimit, you know what I am talking about. I don't know of any respectable value investors who were caught up in the fraud. As a value investor, I could hire a financial forensics expert (read 'Confidence Game' - Bill Ackman did this when he was researching MBIA) that could look for such shenanigans in my positions, if I am taking a large position and wanted to protect my interests. It isn't that companies in the US are leaving material information out (although they do that sometimes), but they are misrepresenting it in a way that is not obvious to an ordinary analyst.

I will leave the case of Madoff and other such investment advisers out, because they are irrelevant to the value investor who is equipped with Charlie Munger's Psychology of Human Misjudgement.

Lastly, Warren Buffett has said on several occasions that he has never relied on credit rating agencies. Again, its a good example of information you cannot trust, but this case is irrelevant to value investors. A value investor is not buying AAA rated securities without knowing whats under-the-hood. If he is, I argue he is not a value investor.

In the case of Indian securities markets, I will site one anecdotal example (I have many more that made interesting dinner table conversations when I was growing up but I will stick to one for now). Again, one example is not representative of the entire market, but I will provide later commentary on why this is important to recognize. I will leave actual names of companies and people out to keep them anonymous.

In the first case, one of my uncle is a large regional distributor in a publicly owned manufacturer of specialized steel in Western India. He has been with the company for a long time and had acquired a large block of its stock over the years. He owned about 5% of the company. The company's director was in late stages of a negotiating a merger with a multi-national steel manufacturer. This information was private and confidential. Given the materiality of this information, it was illegal for him to trade in the stock. So, he set up an "operator" to acquire big blocks of stocks from the open market. My uncle and the director had been close friends for many years. But, in this case, he recommended (lied) my uncle to sell all his stocks (again illegal) because the next quarter was going to be unexpectedly bad, and hence he will get a chance to buy it back at a lower price. My uncle took this information and acted on it (stupid in my opinion - he should have questioned his motives). The director acquired the stock in the open market through the operator. The merger was announced in a month or so at a price 6x of the price that my uncle sold the stock. He lost a fortune, and regrets to this date. Obviously, this was all done in a hush hush manner, and there is really no evidence to prosecute anybody. I am very confident that the transaction between the director and the operator was done in a way that was left no paper trail. Besides, given the culture of rampant corruption, money can get you out of most situations. So, even if they were busted, I don't have (maybe wrongly) the confidence that people fear the consequences, and hence this kind of manipulation ("operators" making the market on behalf of insiders) is quite common.

Now, contrast this with all the insider trading going on with Mr. Rajaratnam. All the people involved are being prosecuted by SEC. This gives me a lot more confidence that market manipulators that trade on inside information are not going to be cut loose.

This is the part that I am not confident - insiders purposely not letting the share prices of their stock reach fair value (because of their hidden agendas) or artificially inflating the share prices through manipulation. If governance in US is a problem, in India its horrible. The board members usually on these companies are puppets (family members) of the CEO.

Adib Motiwala
Adib Motiwala - 4 years ago
Is the example that you gave of your uncle representative of the Indian market? Are you sure that such things do not happen in other countries? Are you suggesting that one should take this one example that you presented from personal experience and extrapolate to large scale fraud, insider trading, shell activities and poor corporate governance?

In one of the largest scams in India, Harshad Mehta was found guilty and put in prison. So, I cannot say that such things are not acted upon.

I do not wish to post further on this topic as I think we are straying from the original post. I think Jacob who is a friend wanted to give a few bearish reasons why he would avoid the BRIC countries. I think he also may have meant to avoid them as an index. I wanted to present some of the positive sides to the story (specifically India) and said that on an individual company basis, there is more potential to invest in the small caps and mid caps in India.

The last 20 years have been good for long term buy and hold Indian investors such as my dad who had a ton of large cap blue chip names and emerging companies such as Infosys. He has been well rewarded.

I am very bullish on the next 20 years for Indian investors even if you invest via the index. Ofcourse, you will have lot of volatility and lot of bearish news about potential nuclear war blah blah blah. Time will tell.

Egardner
Egardner - 4 years ago
I agree with the overall hypothesis of this article, but am not as bearish on Brazil or Russia. I think that most negativity on Brazil comes from unfounded political concerns. However, I think India is going to be the next panic situation within emerging markets. I wrote this article not to long ago, essentially comparing the Argentina default to the current situation. To go all in with the emerging markets is a mistake, but to miss them complete is one as well.

[/url][url=http://www.ericgardner.net/archives/62]Emerging Bond Markets: The Next Bubble?
Sivaram
Sivaram - 4 years ago


EGARDNER: "I agree with the overall hypothesis of this article, but am not as bearish on Brazil or Russia."

Are you talking about being bearish on the economy or on the securities of that country? I ask because, of all the BRIC countries, Russia is the absolute worst. Its economy may be ok--too cyclical but anyway--but when it comes to investing in shares, it's a minefield. Property rights is almost nonexistent. I mean even powerful companies like BP have been squeezed out of their rightful rewards.

As for India, I agree with your stance. Unless India gets its fiscal deficits under control, it's highly vulnerable to capital flight. Of all the BRIC countries, India is the one most likely to experience high inflation while China is the one that is most likely to experience high deflation.
ma.gen.email
Ma.gen.email - 4 years ago


IT CONSULTANT: "Countries such as India that are fiscally disciplined, growing young population, excellent education, and people who are net savers are going to be better places to invest."

I don't know much about India and haven't checked lately but India has been running a current account deficit for quite a while. It has also been running big budget deficits and has a relatively high debt (for a developing country.) Apart from political risks, I would say this is the biggest risk for India.


Great discussion, and I don't have much to add, but I will say this: Although India's debt to GDP ratio is relatively high (~80%), and it ran a deficit of about 7% in 2009, its external debt is only about 22% of the GDP, and its foreign exchange reserve to external debt ratio is about 130% ($280B vs. $220B). Also, a fifth of its external debt are deposits by Non-resident Indians, and about 40% of external debt is short-term. And, more than half of its external debt is dollar denominated.

While debt in any form tends to be dangerous, the fact that most of its debt is internal and in its own currency makes the situation slightly different than most of its peers. India's central bank has been running a pretty tight ship when it comes to external borrowing, and one could argue this approach (among other things) helped India survive the 2008 financial crisis in a relatively stable condition.

I agree with most other caveats mentioned by various posters above, especially regarding the quality of financial statements and publicly-available information. Based on our experience in investing in Indian public companies, one has to always assume that there are two books, and widen the margin of safety to include that possibility. However, we have also found -- much to our surprise -- that the fin statements of the govt-run companies with public offering (e.g. BEL, BHEL, etc.) tend to be much cleaner than their private counterparts.

The Maoist threat seems to be a bit too exaggerated by the map, which is a bit misleading since it source (_http://satp.org/) doesn't clearly define what "affected" means. Having grown up and spent time in some of the "impacted" areas on the map, I can tell you the local population doesn't necessarily view the maoists as much of a threat. Its impact, reach, and risk potential are probably similar to that of the KKK during its peak in the US. However, since India's enforcement of its laws is not as strong as it needs to be, they probably get away with more violence.

The threat of a nuclear escalation with Pakistan is a greater threat in my view, and it parallels the threat the US faces from that region: extremists gaining access to the nuclear arsenal that Pakistan's relatively-weak infrastructure and safeguards currently protect.
DaveinHackensack
DaveinHackensack - 4 years ago
The country experienced a massive economic crisis only eleven years ago. Has so much changed then, and is this time different?

Plenty has changed in Brazil in the last decade. If you aren't aware of the changes (e.g., several years of record trade surpluses, increased political stability, a transition from big deficit spending to running primary budget surpluses, a strengthening currency, having its credit rating raised to investment grade, etc.), basing your bearishness on a near-term surge in imports seems like you were just looking for something to fill out this article.

The Brazilian economy may be at risk of overheating, but that's a better problem to have than the one we currently have with our economy. Brazil's central bank has already raised rates over 10%. That means it has plenty of dry powder in terms of monetary policy if its economy starts to slow.

I can understand how you might be bearish on Brazilian stocks and US stocks based on fears that the global economy will weaken. I can even understand why you might be bearish on Brazilian stocks because you think that Brazilian stocks will get hit harder due to investors 'flight to quality'. But you haven't made those arguments. You've just alluded to macro risks and said that investors have high expectations about Brazil's future growth. Perhaps, but if so, it doesn't look like they've priced those expectations into stock market valuations. According to the FT, the average P/E on Brazilian stocks is 14.9 currently with a dividend yield of 2.8, versus a P/E of 16.8 on U.S. stocks and a dividend yield of 2.0.

According to Warren Buffett (and Jeremy Siegal, I think, as well) to estimate long term stock market returns, you add the expected GDP growth plus inflation, plus dividend yields. Based on that arithmetic, wouldn't you expect long term stock market returns in Brazil to be higher than in the US?

Again, I can see why you might be bearish on Brazil due to concerns about a correction/flight to quality, but I can't see how you would be bullish on US stocks at the same time.

superguru
Superguru - 4 years ago
ma.gen.email wrote:

"While debt in any form tends to be dangerous, the fact that most of its debt is internal and in its own currency makes the situation slightly different than most of its peers. India's central bank has been running a pretty tight ship when it comes to external borrowing,..."

"Based on our experience in investing in Indian public companies, one has to always assume that there are two books, and widen the margin of safety to include that possibility...."

"The Maoist threat seems to be a bit too exaggerated by the map..."

ma.gen.email - Excellent points. You expressed the complex situation in India the best so far.

Daveinhackensack - great point as well about flight to safety.

Jacob's article is a good example of how difficult it is, by just reading some headlines and articles, to gain understanding of macro economic situation in different countries and cultures. Media cannot be relied upon. You might as well watch a hollywood movie to understand how world works. Thats why it is better to stay in circle of competence as Ravi mentioned.

I use Mutual funds/ETFs to invest in India (MINDX) and EMs and in US I buy stocks (and Fairx).

I am long term bullish on EM and BIC though after the bull run in Indian markets I am cautious now.

Will these countries have high volatility and booms and busts like US and Europe? - Yes.

for me volatility = opportunity.

Alex Garcia
Alex Garcia premium member - 4 years ago
Dave wrote:

"Again, I can see why you might be bearish on Brazil due to concerns about a correction/flight to quality, but I can't see how you would be bullish on US stocks at the same time."

I'm definitely not bullish on the U.S. economy due to mass debt problems but couldn't one make the case certain stocks are undervalued based on earnings yield and earnings power value (EPV; Greenwald) and thus one could be bullish on those particular domestic stocks.

In terms of the BRIC countries, it's a tough task to make a bearish argument. You could probably make one for Russia and its political environment, but one would have to make the same case for the Chinese and Indian governments. They have a lot going for them and like Dave mentions, they have a couple more bullets than the U.S. Govt , who is obligated to keep rates near 0%

Sivaram
Sivaram - 4 years ago


DAVE IN HACKENSACK: "According to Warren Buffett (and Jeremy Siegal, I think, as well) to estimate long term stock market returns, you add the expected GDP growth plus inflation, plus dividend yields. Based on that arithmetic, wouldn't you expect long term stock market returns in Brazil to be higher than in the US?"

I agree with most of what you were saying but this is an important topic in itself so I thought I would poke a hole in it. Sorry about going off-topic...

What you quoted is missing a very important element. That factor is the share of the GDP growth that accrues to capitalists. A lot of people ignore that factor and it may be meaningless if looked at most liberal, developed, countries but I would argue it is a different game when you step into emerging markets or frontier markets.

For instance, it's not at all clear that much of the profit in China will accure to owners of businesses. No one knows for sure but many reports have suggested that companies don't earn much in China. So, if one blindly applied that formula you quoted, some country like China will appear to have really high expected returns (because GDP growth plus inflation is really high.) But it wouldn't be all that surprising to me if US corporations generate higher returns than Chinese ones.

To put it another way, American corporations are efficient and earn a huge chunk of the profit in the economy. Their very-long-term (80+ years) ROE (return on equity) of around 12% is probably the highest in the world (ignoring little countries and special cases.) If Chinese or Indian or Brazilian or whatever companies only end up with an ROE of, say, 8%, will they actually generate more wealth for shareholders than American ones?

Something to think about...

Once all the hype is done and all, what matters for shareholders is how much money accrues to them.
CMW
CMW - 4 years ago
The author is right about a lot of things in my opinion. Nobody questions the future economic growth of these places. They all have some mix of big populations, natural resources, education, etc and are starting from a small economic base. Growth is assured over time.

The problem is making money from it as minority investors. Russia is a cesspool. China and India are dodgy. Brazil? Ask "B" holders of Aracruz (which even had a ADR) about shareholder rights there.

Adib Motiwala
Adib Motiwala - 4 years ago
CMW.

On what basis do you say India is 'dodgy'? Or what did you mean by that?

Sivaram,

Have you looked at the valuations/results of Indian firms to arrive at a conclusion that their ROE may be as low as 8%? Infosys (INFY) has returns well over 20%.

Do you guys think its possible that all or a majority of the companies were cooking books or were underperforming but the index would go up 18x in 20 years? Has anyone done any real research in the Indian markets before passing generic statements?

I would urge you to go and check some of the companies listed in the US as ADRs.

Infoysys (INFY), Wipro (WIT), : IT Services powerhouses of the world.

Tata Motors (TTM) : Large car manufacturer in India.

ICICI Bank (IBN) : Large bank

Dr Reddy Labs (RDY) : Generic drug powerhouse, smaller than Teva Pharma.

These are some of the bigger names. Most of these are represented in the Index.

Good sites for research in Indian markets are

www.moneycontrol.com

http://economictimes.indiatimes.com/

Check their sales and earnings growth, dividend growth, book value growth, ROE, ROC over the years.

Egardner
Egardner - 4 years ago
Are you talking about being bearish on the economy or on the securities of that country?

I was taking about the overall economy, but you are totally right when it comes to investing and doing business. I currently intern at the Department of Commerce and we routinely advise against even investigating exporting to Russia.

Adib Motiwala
Adib Motiwala - 4 years ago
Check this video for a discussion on US education v/s India and ( China )

http://www.youtube.com/watch?v=2zAFq-hwfbA
CMW
CMW - 4 years ago
For low double digit PEs, you can buy some of the biggest, safest, cash flowing and cash rich companies in the world, with huge exposure to overseas markets, and listed in the most liquid and safe market in the world, with some growth (admittedly not exciting but fairly certain). But you all want to pay a premium for BRIC stocks. I thought this was a value website.
Adib Motiwala
Adib Motiwala - 4 years ago
Atleast I never mentioned high premiums for Indian stocks. I was saying that to paint entire countries with a broad macro economic brush and to think that entire market is over valued is incorrect. I infact recommend to invest in individual stocks that may be still cheap , even though the index may be fairly valued.

I agree with CMW about quality blue chip stocks being cheaper in the US.
LwC
LwC - 4 years ago
The link below connects to a program called "The Changing World" from the BBC World Service. The first half of the current program, called "Tiger Versus Dragon", reports on the economies of China and India.

http://www.thechangingworld.org/

The second half of the program focuses on the military rivalry between China and India.

Sivaram
Sivaram - 4 years ago


ITCONSULTANT: "Sivaram,

Have you looked at the valuations/results of Indian firms to arrive at a conclusion that their ROE may be as low as 8%? Infosys (INFY) has returns well over 20%."


I was just speculating and wasn't referring to any country in particular. So, no, I don't know what the ROE on Indian stocks are. But without even looking it up, I'll bet it is nowhere near American companies. My guess is it's between 5% and 8%.

As for your mention some companies like Infosys, those are only a few and not reflective of the market. For instance, Japanese companies have very low ROE--companies are not run to benefit shareholders--but their foreign multinationals like Toyota have higher-than-industry ROE. But that doesn't mean much if you are talking about the country itself.

As for the strong performance in the past, that doesn't mean much going forward. The strong numbers for those companies likely won't be repeated in the future. For instance, how much more can a company like Infosys grow?
Adib Motiwala
Adib Motiwala - 4 years ago
Siva said

"I was just speculating and wasn't referring to any country in particular. So, no, I don't know what the ROE on Indian stocks are. But without even looking it up, I'll bet it is nowhere near American companies. My guess is it's between 5% and 8%."

Thats a poor statement. You just said you are speculationg. Then you continue and guess that its 5% - 8%. You need to have facts before you can make such statements.

Also, are you taking All US companies as average or Large cap?

You said Japanese firms had low ROE. Well, maybe that is why their 20 year stock market performance is nothing and its said they had 2 lost decades. Just like the US market had a lost decade!!!!

"For instance, how much more can a company like Infosys grow?"

Check the growth of IBM over 100 years. Its still growing. IT service companies have lot of room for growing sales. Infosys has been a multi bagger possibly 100 bagger or more in 20 years. I cant be sure but I would speculate Infosys will reward shareholders.

Please check atleast 30-50 big names of India and then comment on their ROE and shareholder rewards.

rgosalia
Rgosalia - 4 years ago
itconsultant,

You seem to have spent time analyzing the large cap stocks in India. I am sure, like me, many others will be interested in reading your analysis of these large caps. In your previous posts, you mentioned a few names - Infosys, Wipro, Tata Motors, ICICI bank, Dr Reddy Labs.

I suggest that you post your analysis of each of these names and your view on how cheap these stocks are relative to your estimate of intrinsic value.

I think this thread has been going on for a while with lots of different view points. My view point is that I would require an extremely large margin of safety for me to invest in mid and small cap stocks in India because of (perhaps skewed view based on my personal experiences) the likelihood of manipulation in these stocks. But if you have a view that the large caps are cheap and attractive at current levels, you have my attention (and I am sure many others will want to read it). Your time spent on writing an article on each of these companies will be well spent.

In the end, this is a value investing website, and we ought to be looking at an idea at a time rather than talking in generalities, and you posting your analysis on each of these names is what this website is about.

Regards,

Rishi Gosalia
Adib Motiwala
Adib Motiwala - 4 years ago
Rishi,

Those names were mentioned as examples of Indian companies listed as ADR's in the US. I did not say these are over or under valued individually. I will try to do some research on some names and post it on GuruFocus if possible. I know these names from my Dad's holdings.

The speculation on the forum was of the following kind

- the books are cooked or cant be trusted

- ROE is surely low 5-8%.

- There is more fraud in India in small caps. Cooking books.

- People not booked for fraud in India.

- Threat of nuclear war. War can break out any time!

- Maoists taking over large parts of India. almost entire East India as shown by a map.

I think a lot of these are just speculations and have no basis to them. How come no one talked about the Indian stock market up 18x in 20 years? I know its past and no guarantee of future performance. But, are you really thinking that all the companies in the Index would be performing at 5-8% ROE and have such returns?

I cannot believe even after so many years of Indian stock market performance and companies getting listed in the US, companies doing business all over the world, people visiting India and democracy of India, people pass such broad baseless judgements.

I am daily reading news in WSJ about fraud and deceit by large US companies. Example Citigroup for example lied about the extent of sub prime loans on its books. And the fine was a mere $75 million. Lots and lots of cases of fraud, deceit and shareholder unfriendliness by several companies including excessive compensation. However, people turn a blind eye to that and say US has the best financial system. There is no fraud here. And all other '3rd world / emerging countries' have all the issues, frauds, double books!!

rgosalia
Rgosalia - 4 years ago
itconsultant,

You are right in pointing out that the comparison has not been one of apples to apples - its been one of overlooking issues in the US, but overlooking the positives in emerging countries.

If we think at a higher level, lets look at the intent of having a margin of safety when investing in individual securities. It is to protect against all the unknowns - cooking books, frauds, financial shenanigans, lies by the management and whatever else. If one has invested with a proper margin of safety then one will come out fine on an aggregate basis. This is a key principle of value investing and it does not change whether investing in the US or in emerging countries.

My only point in one of my previous post was that I was unable to find anything in India in the small and mid caps, not because of some generalizing view, but based on the then valuations of the companies I looked at and the margin of safety they offered. I required the margin of safety to be larger than for an equivalent security in the US. The reason for this is not because I think shenanigans don't happen in the US (you are right in pointing out that they do happen here too), but I feel I can evaluate (based on the management compensation disclosures in the public statements and various other readily available public disclosure documents) the management team for a US company with a much higher precision than one in India. I will acknowledge that I can always go wrong, but I think that the chances for me to do so are much smaller - since this is where my circle of competence lies. Now, if somebody else has this kind expertise for Indian companies (of separating the wheat from the chaff), he may not need to have the same margin of safety that I look for in an emerging market company.

However, I feel a lot of people are only doing high level statistical analysis of the stocks without thinking about the incentives of the management team and its long-term orientation (both in the US and in emerging countries) and investing with an insufficient margin of safety. On a long-term basis, I think these investors will get burnt (independent of the country).

I can see your frustration with the generalized statements posted by many (some by me too) - but I think its because all of us have a certain notion (sometimes preconceived and sometimes not) about investing in an emerging market. The only way to convince a value investor otherwise is to show individual securities that offer high reward but without taking unnecessarily high risk through an appropriate margin of safety for that security. Post some examples of these and you can take the skepticism away.

Since I am asking you to post idea(s) from the emerging countries that meet the criteria I laid out, to be fair, I feel compelled to do the same for developed countries. I have already done so for two (Ensco and Accor) of my top five positions. (My top five positions are Winthrop Realty Trust (invested during the flash crash at 10 some dollars), Leucadia (invested at 15 some dollars during the height of the recession), Ensco (invested at 38.67 during the BP accident), Berkshire Hathaway, and Accor (invested at 33 some euros)). I doubt any one needs a post on Berkshire or Leucadia, but I may get one on Winthrop in the future (although it may be not be as interesting now since its run up 12% since the flash crash and the margin of safety is much smaller than at my entry point).

Rishi
Adib Motiwala
Adib Motiwala - 4 years ago
Rishi,

thank you for your last post. I agree with you about the margin of safety requirement and that you may need a higher one for other countries where you normally do not invest or have less confidence.

Your point is well taken. I hope to be able to do some research and present it here.

CMW
CMW - 4 years ago
Well said Rishi. I would add that if you do not thoroughly understand a foreign country's legal system:

- what rights are attached to a common share certificate

- rules and enforcement level for criminal behavior in government and at companies

- the bankruptcy process

then you are gambling not investing. You are attaching a comfort level around valuation metrics that probably doesn't exist. It is easy to take for granted the market and legal system we have in the US, but I would argue it is a hundred years ahead of most emerging markets. This is especially important for investing in smaller companies.

I'm not saying don't look at these places, because there is going to be a lot of growth. But don't kid yourself either. It is the wild wild west of investing. You need much lower valuations on that growth and more diversification to be safe.

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK