My friend Eric Kraus sends the following note this morning from frigid Moscow:
“One of our friends, on the Russia sales desk of a major Western institution, has just got back from marketing in the United States and tells us that 100% of the American accounts expect an imminent revolution in Russia… Yes, we knew that marijuana has been essentially legalized in California; however, we had not realized that its use was quite that widespread, nor that it had so affected the ability to process information.”
Eric is a money manager who has been living in Moscow for the last 20 years or so. He also pens the insightful (and funny) Truth & Beauty letter on Russian finance. Eric writes irregularly, seemingly only when something irritates him enough to rouse him out of his lair. In this case, it was the hullabaloo about the outcome of the recent Russian elections. The Western press seems to think Russia is about to crack. Eric finds the idea absurd, as the above quote shows.
You may not care a whit about Russian elections. But I imagine you care about your investment portfolio. And Russia is one member of a quartet called the BRICs. Brazil, India and China are the other three members of the band. If you invest in resources (among other things), then the tune these guys play will have a big say in whether you make money or go broke. Let’s take a look.
I begin with Brazil. I saw this coming many months ago, and now it is on the front page. The Financial Times ran it last Wednesday: “Brazilian Growth Shudders to a Halt.” The Brazilian economy actually contracted in the third quarter.
This is no surprise at all. Brazil has a demonstrated knack for self-destruction. But beyond that, the personal debt figures in Brazil are scary. Plus, Brazil is a tough place to do business. Reams of regulatory red tape choke off investment flows and make it hard to earn a buck. Tech Data was the latest firm to find that out. The leading distributor of IT products decided to close its Brazilian operations.
The press release was blunt about why: “The closure is due to Brazil’s complex tax, legal and regulatory environments, which make it difficult for the company to generate a sufficient return on invested capital.” And again later in the release, “Despite our team’s best efforts, the complexities of operating in Brazil have prevented the company from attaining the level of profitability needed to earn an adequate return on our investment.” People who like Brazil as an investment destination seldom talk about this.
So Brazil has problems. Its economy shrunk, and things could get worse before they get better. Part of Brazil’s pain is due to China, an important customer, which reported last week that manufacturing activity contracted for the first time in three years in November.
China, of course, affects everything. A slowdown there creates pain for natural resource prices. But it goes beyond that. Slumping Chinese demand also dropped petrochemical prices to the lowest levels in about a year. Petrochemicals go into making, for example, plastic. China is the biggest importer and exporter. It imports commodity plastics and turns them into plastic bags, toys and other junk people buy at Wal-Mart. So now you have DuPont, Dow Chemical and others dropping profits and forecasts.
What’s interesting about China is how many people seem to take it for granted that it will grow. It seems like all of the big investment houses project 8% growth for China in 2012. The Asian Development Bank has its “worst-case scenario” at 5.4%. Stone-hard consensus thinking like that always worries me. In any case, China is clearly slowing down.
What about India? I won’t spend much time on it, but I would like to point out that India made a huge breakthrough when it opened up its domestic markets for foreign retailers. This is a big plum on the international investment scene. Many have been waiting for years for the opportunity. And now, suddenly, Wal-Mart, Apple, IKEA and others can open up shop in India.
Except they can’t, because the government reversed its decision after a wave of popular protest. It was an embarrassing setback for the government led by Prime Minister Singh. But more importantly, it shows just how long India has to go and how it is, still, far from a market-friendly, open economy.
And it’s slowing down, too. As the Financial Times notes, “China, Brazil and India, the three largest emerging-market economies, are all now slowing.”
Which brings us back to Russia.
Russia has a PR problem. (Eric says that the Russians could make themselves look bad handing out Christmas candy to orphans.) There is corruption. There is the heavy-handedness of Putin and silliness of his puppet, President Medvedev. And there is the Western view that the whole place is about to implode.
The latest issue of The Economist has a menacing-looking Putin on the cover with the headline “Putin’s Russia: The Cracks Appear.” Inside is a lengthy look at Russia.
I can barely read the Western press on Russia anymore with anything other than extreme distrust after reading Eric Kraus over the years. Eric points out that while the Western press jumps on the election results as a slap in the face of Putin, they are, instead, a slap at President Medvedev. This is from Eric’s morning note:
“The elections represented not just protests against corruption, deeply uninspiring politics, bad weather and a slowdown in economic growth (to a still-respectable 4% per annum), but also far more importantly a sharp reaction against the liberalizing, pro-Western line embraced by President Medvedev. We remind the reader that the liberals of Yabloko took a thumping 3% of the vote — the Communists and hard-line nationalists a combined 33%. This is no Orange Revolution…”
He maintains that Putin is still quite popular outside of a small sliver of Moscow elites enamored with Western ideas. He doesn’t think that Russia’s political system is necessarily sustainable, as it is held together by one mortal man. This is in contrast to the Chinese, who have a political system that has shown the ability to pass the baton to different leaders in the party.
But the key thing about Russia is that its economy is still growing. The election results, Eric believes, won’t interrupt that growth materially:
“Investment implications are pretty much nil — much ado about very little. One can expect a somewhat more-stimulatory fiscal policy, with a shift toward a more-statist model. Given our (once again, verified) bullish call on oil, there is no threat to Russian macroeconomic stability within the foreseeable future. That said, the mood among foreign investors will be sour, leaving the less excitable among our readers the opportunity to pick up some cheap assets.”
Maybe so. But even Kraus is hedging his bets: “For now — given the havoc in Europe — Truth & Beauty will stick to the bonds.”
I think the overall portrait the BRICs paint goes far in explaining why the stock market is having a hard time. Yes, the EU gets most of the attention. It’s not undeserved. The EU is a big market, and it looks like it’s about to slip into an abyss. But the EU has been a low-growth, sclerotic market for a long time.
The BRICs, on the other hand, have provided the big growth in recent years, especially coming out of the financial crisis of 2008. More and more, it looks like that won’t be the case this time around.
Still — Opportunities Abound!
Over the longer term, though, the growth is with these markets. So while these troubles could tank stock prices and hurt earnings for the fourth quarter, I think it would be foolish to walk away from emerging-market themes if you have a longer-term perspective (anything measured beyond four quarters). I also think there are great opportunities in emerging markets other than the BRICs.
I was recently in Vietnam, a market that is also having problems. Inflation is out of control, with prices rising around 20% annually. Vietnam is also like China in that its government directed a lot of investment in things that soured. The banking sector, therefore, is riddled with worms. But at a price, things get interesting.
Marc Djandji is the head of research at Viet Capital. I met him in Saigon while I was there last month. He sent out a note last week that summed up the situation there pretty well:
“Is it really all doom and gloom? Sure, the VN-Index has lost 20% year to date and the HN-Index a whopping 46%. High NPLs [nonperforming loans] have banks seeing red, high lending rates have companies seeing red, high inflation have consumers red in the face, but with Tet just around the corner… the only red we want to see are red envelopes. With all the pessimism out there, it’s easy to get caught up in the glum, but banks are still open, farmers are still planting, construction companies are still constructing, manufacturers are still producing, people are still eating, working, playing. In other words, money is still being made and is still flowing in the system.”
I think this way about all markets. You can easily get caught up in the doom and gloom, but the fact is life goes on. If you can stick it out, there are often great opportunities in such cheerless environments.
At some point, the market compensates you for taking risk.
Djandji remarked on the facelift the provincial capital was undergoing as investment flows into the area. “New roads, sidewalks and parks were being built, and they were putting the final touchups on a beautiful government office built in traditional Laotian architecture while we were there,” he wrote. “One cannot help but wonder what this sleepy town will look like in three-five years, when the 20,000 workers needed for its factories and plantation flock to the area.”
This gets to the point I am making about the emerging markets as a source of long-term growth. When I talk to people like Djandji and when I go on my own investing field trips, I get excited about being an investor today. There is just so much potential, so much still to do! Taking the long view, we are still in the early innings of the emerging markets emerging.
Years from now, many of these places will look entirely different. There will be more cars, more roads, more food produced, more goods, more trade and more people… The world will consume more of the valuable things our companies produce.
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