The Strongest BRIC Country

I have a trick question for you, especially if you’re interested in emerging markets:

Among the four BRIC countries — Brazil, Russia, India and China — which offers the best stock market performance for American investors?

Be careful how you answer, because appearances can be deceiving, especially if you focus strictly on one year.

Looking at year-to-date results, for example, it might seem that the answer is Russia.

From the close of trading at the end of last year through the closing price this past Friday …

FXI, the exchange-traded fund (ETF) tracking China’s blue chips, is up 45.87 percent …

PIN, representing India’s major stocks, is up 64.16 percent, and …

EWZ, the leading Brazil ETF, is up 104.25 percent. But …

RSX, tracking the Russian stock market, beat them all — up 117.17 percent!

Meanwhile …

The Dow fell FAR behind all four, up a relatively meager 13.68 percent so far this year.

If you had invested $10,000 in the Dow, your gain would be $1,368, which is nothing to complain about.

But if you had invested that same $10,000 in the Brazil ETF, your gain today would be $10,425, or 7.6 times more … exceeded only by a $11,717 gain in the Russia ETF, or 8.6 times more.

Sounds simple, right? Just dump the losers, invest in this year’s #1 winner, and enjoy the ride.

Not quite!

You ALSO need long-term stability — robust national finances … free, democratic societies … and the rule of law. You need stock markets that have withstood the test of time … and, more to the point, have the proven ability to weather — or easily recoup from — an ugly bear market like the one that struck the entire globe in 2008.

So for a quick reality check, let’s push back the starting gate by a year to include the big declines of 2008 as well. Now, suddenly, the contest is no longer about who could have made the most money. It’s about who could have lost the least:

In the Dow, for each $10,000 invested, you’d still be down $1,976 today, even after the recent new highs that Wall Street is so exuberant about …
With the China ETF, you’d be down a bit less — $1,573, saving you from $403 in losses, and …
With the India ETF, your loss would be $1,039, saving you $937.

But here’s where the BIG difference really shows up:

Even with Russia’s spectacular performance this year, investors in the Russia ETF who began with $10,000 at the starting gate, nearly two years ago, would still be DOWN by $4,047 right now — a loss that’s more than DOUBLE the loss in the Dow.
In contrast, investors in the Brazil ETF would be down by a meager $390, or less than ONE-FIFTH the Dow’s loss.

If this were a World Cup soccer match, it would be like 10 penalties against Russia vs. only one against Brazil.

I know. You’re not intrigued by who plays less badly any more than you’re interested in how to lose less money. You want your team to score; you want to make the most money you can over time.

I’ll get back to that issue in a moment. But the key question I want to address right now is this: In the “least ugly” contest of the past two years, why did Brazil trounce Russia by a factor of 10 to 1 … beat the U.S. by 5 to 1 … and also outperform the other two BRIC countries by a huge margin?

The answer takes me back to the all-important stability factors I told you about a moment ago — robust national finances … free, democratic societies … and the rule of law.

China has the first.

The U.S. has the second two.

India is a mixed picture across the board.

But the starkest contrast is between Brazil, which has gone a long way to achieve all three … and Russia, which essentially has none.

Russia and Brazil Compared

I have personal ties to both countries.

My maternal grandparents were Russian; I love the country and its people.

I went to high school, got married and have a home in Brazil; and the only country I like better is the U.S.

Both Russia and Brazil boast greatness in their own way. But when it comes to investment potential and risk, there’s no comparison.

State Control and Corruption:

In Russia, apparatchiks bought up big cross-sections of the nation’s productive capacity for a pittance. And today, there has been very little change in the traditional failure of Russian society to separate the state from private enterprise.

The 19th Century Tsars had undue control over business. So did the 20th Century Soviet state apparatus. And so does 21st Century Russia.

If you invest in Russia, you have to do so with great caution and good timing. For example, managers of The Hermitage Fund, once Russia’s largest foreign investor, apparently expected Russian bureaucrats, tax collectors, police and judges to apply something akin to the hands-off fairness you’d expect in mature capitalist societies. They were dead wrong, and they learned the hard way.

Shell and British Petroleum lost mega-fortunes in Russia because they didn’t grease the right palms. They were wrong too — in more ways than one.

Just in the first half of 2008, $7 billion fled the country. Russian stocks didn’t merely get slammed to the mat like in most other countries. The entire Russian stock market was repeatedly knocked out cold, shut down completely for extended periods of time.

Brazil is an entirely different ball game.

In Brazil, it would be a gross overstatement to say that the state is absent from the marketplace. It owns a controlling stake in the massive national oil company, Petrobrás. And the pension fund of the government-controlled Bank of Brazil is one of the largest shareholders in another huge resource company, Companhia Vale do Rio Doce. Plus, the government plays a key role in business overall.

But, despite some much-publicized shenanigans, the government usually does so within the confines of the law. And more often than not, the most corrupt politicians wind up losing their freedom — or at least their careers — in tough court battles.

Financial Regulation:

Russia’s banking and financial rules are only as good as its shaky legal system — riddled by the same kind of cronyism that doomed the investments of Hermitage, Shell and British Petroleum. And even if you see fewer big-name fiascos like these going forward, there’s little hope that countless small- and medium-sized enterprises will be treated any more fairly.
Brazil’s banking system is the polar opposite, boasting not only better stability than that of the other BRIC nations, but also of the U.S. and Western Europe. Bottom line: Brazil’s central bank is one of the few in the world that has strictly applied the higher capital standards recommended by the Bank of International Settlements — not only for high reserve requirements but also for reducing risk taking.

Democracy:

Russia is democratic in name only. The ruling party has squashed virtually all opposition, and the press is “free” only so long as government criticism is virtually muted.
Brazil has enjoyed a democratic multi-party system for 25 years, with two strong parties taking turns governing the country, and, remarkably, with the world’s most advanced computerized election system.

Society:

Russia’s recent growth has come with an intolerable social cost — a 30 percent jump in the number of people living in poverty along with extreme conspicuous consumption by the wealthy few.
Brazil’s recent growth has been largely fueled by a dramatic expansion of the middle class and a reduction in the poverty rate. Tens of millions of citizens who were totally outside the economy — without a penny of savings or even a formal address — now have steady income, bank accounts, credit, cell phones, and most important, the ability to consume.

My Recommendations

First, regarding the goal of making more money — as opposed to merely losing less — just go back one year further to cover nearly a 3-year time span. You’ll find that, from the beginning of 2007 through last Friday …

Investors in the Dow have lost 17.2 percent of their money; investors in Brazil’s ETF (EWZ) have gained 68.6 percent.

Second, looking into the future, recognize that controlling RISK is just as important as grabbing opportunity, something you can do in three simple ways:

Diversify. I’m not talking about the traditional Wall Street strategy of spreading your money around several domestic sectors — that’s not nearly enough. Rather, I’m referring to far broader diversification — across national borders, asset classes, instruments and strategies.

Don’t buy and hold. Even if you missed the tops and bottoms … if you had simply followed our recommendation to exit nearly all markets in 2007, your overall performance could have been infinitely better. Likewise, when and if we feel the current BRIC boom is nearing an end, we’ll do our best to warn you ahead of time.

Measure performance over more than just one year. That means including the worst years (like 2008) as well as the best (like 2007 and 2009).

Warning: Each of these steps will be especially important next year, when a whole new set of surprises are likely to hit. Stand by for more details.

Good luck and God bless!

Martin

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Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amy Carlino, Selene Ceballo, Amber Dakar, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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