Busting Myths and the Negative Narrative on BRICs
January 13, 2014, 6:53 am

“Other people’s beliefs may be myths, but not mine.” – Mason Cooley

There is no doubt about it – for the past several years, emerging markets have been a poor trade and an even worse investment.  Despite higher growth than developed economies, and better valuations, money has simply rewarded the proactive printing press as opposed to more longer-term potential.  The media has been largely focused on the idea that emerging markets are in crisis mode, using the narrative of Federal Reserve tapering as the reason for why stocks in Brazil (EWZ), Russia (RSX), India (EPI), and China (FXI) are doomed to perpetual underperformance.

At the 5th BRICS Summit in Durban, Putin likened the group of 5 to Africa’s “Big Five” game beasts of trophy hunting lore – the lion, elephant, buffalo, leopard and rhinoceros [GCIS]

This brings us to the second myth to attack – the idea that a crisis is underway in BRICs.  Yes – China has significant debt and may be risking a credit crisis.  But risking a credit crisis in the future is different than pricing a crisis as if it has already happened.

To argue that debt alone is the reason not to buy emerging markets ignores the fact that US liabilities are likely considerably higher than China’s, once unfunded liabilities are factored in.  Brazil’s problems are all well publicized.  India has taken aggressive, proactive actions to reduce deficits and stem currency declines.  Russia’s valuation multiples are in the low single digits.  In 2013, emerging markets lagged US equities by the most since 1998 when a true emerging market crisis actually occurred.  No such crisis has, for lack of a better term, emerged.

Investors watch the electronic board at a stock exchange hall in Jiujiang, China [Getty Images]

The situation is entirely different now with the Federal Reserve actually tapering.  Take a look below at the price ratio of the iShares JPM USD Emerging Market Debt ETF (EMB) relative to the US iShares 7-10 Year Treasury Bond ETF (IEF).  As a reminder, a rising price ratio means the numerator/EMB is outperforming (up more/down less) the denominator/IEF.

Note the collapse in the ratio as US yields spiked, and the considerable resilience now.  If there were a crisis and the breakdown in the equity side of the BRIC equation were valid, would not debt feel the impact of a breakdown even more?

That is not to say of course that emerging markets do not have problems.  Of course they do.  But at the end of the day, the business of trading and investing is not about whether things are good or bad, but about if prices have overreacted or underreacted.  For emerging market stocks in 2013 to have behaved like they did on a relative basis to US markets as if a 1998 crisis took place is illogical.  So too is assuming that the suppliers of developed markets will not participate in developed economic accelerated growth.

While momentum remains short-term negative, do not discard BRICs from your trading screens.  After all – when BRICs move, they tend to do so sharply, violently, and in a way that usually is too late for most to take advantage of after the fact.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.