Simplifying BRICs

GUEST COLUMN

The performance of the Russian market over the last seven years throws the BRIC emerging growth model out and suggests it was more about the commodity boom.

"Simplicity is solved complexity," said Brancusi, a renowned Romanian sculptor and poet, and that is what we have tried to address in 2007. In this column, we look at attempt to simplify another term that was included in the economic lexicon in October 2003 when Goldman Sachs came up with the global economic research paper "Dreaming with BRICs".

Though the forecast was simple that the BRIC countries were in for glorious times ahead till 2050, what our in-house cyclists were questioning was how these economies would overcome the decade without a serious blip and the Benner cycle lows in 2011. The dreaming part was otherwise good. We, anyway, decided to have a relook at the BRICs.

So how strong are the BRICs four years after? What are the rankings? Where does India stand? Is China really a key BRIC? Is it true that BRIC was always and is an important strategic investment region? And where are we all headed by 2010? What are the leading indicators, if there are any? Are there chances of a serious chaos in the utopian glory?

The report starts with a brief mention of the changes in the last 50 years and how the next 50 years might be equally dramatic. From an econohistory point of view, we saw no major wars, no global depression and a healthy disinflation on the positive side.

On the negative we saw two crashes in United States, the crash of 1987 and the tech bubble bust in 2000, a credit mess and housing market crash in America, a US bear market from 1964 for nearly 10 years, a 13-year depression in Japan, a commodity boom in the eighties, followed by a commodity bust for 20 years till 2000.

In the BRIC bloc, we saw multi-year consolidations in India, China and Brazil, and a crisis in the Russian market. So we have enough volatile signatures about times ahead, 50 years and maybe more. There is documented cycles research available on the alternating power cycles between the western world and Asia.

The research illustrates cycles as large as 510 years. The latest cycle started in 1980 and should continue till 2490, much beyond our lifetime. The cycles study has been done since 670 BC when the Roman Empire strengthened, on the formation of Great Britain (one of the G6) and till modern times.

But then like we said, it is the multi-year wealth generation and wealth destruction cycles we are more concerned about, specially the one heading into the end of the decade. One such cycle was developed and written by Samuel T Benner in 1875 in his book Business Prophecies of the Future Ups and Downs in Prices.

Benner observed that the highs of business tend to follow a repeating eight-nine-ten yearly pattern, while lows followed a 16-18-20 year sequence. Looking back at these cycles from 1902 the next significant business low should be in 2011. The rules of fixed periodicity for anticipating changes are mechanical and do not allow for any assessment of the economic factors.

Strange as it may seem but most of the BRIC countries made a cyclical low around 1995. Brazil made a primary low in 1995, Russian RTS made a low in 1996 but retested it again making a marginal new low in 1999, the same was true for the Shanghai Index, which hit its primary base near 1995 and finally the Indian Sensex 1995 low was marginally breached.

Most of these 1995 lows were followed by multi-year slowdowns. Now if the cyclicality is to be believed we are headed for another cycle low in 2011. The very fact that markets have not corrected till now and we are heading into the cycle low zone suggests that the corrections should be sharp and not the slow sideways that we saw during the start of the cycles.

One might still debate how the US stock cycles might be fitted on the emerging market block. Market cycles just like fractals are not only indistinguishable over various geographical regions but also across assets.

And above that, all of them are de-trended sine curves with enough back-tested proof, which makes them significant. In crux we are talking about high probability projections not about an econometric result dependent on economic policies and a host of other parameters assumed to be constant.

The relative alpha for BRIC markets was clear after 2000. And the Goldman report did time that, as BRICs barring Russia grew at a multiple of three times that of Dow Jones over the last seven years from 2000 along with the strengthening of the local currencies.

But the report missed to call it a global equity bottom in 2002, just like few other high-merit research institutions failed to see the 2000 top or fail to see the 2011 impending low today. The report did provide GDP projections but it did not articulate the relative attractiveness of the BRIC countries.

Though the BRIC countries were mentioned as the new global engines, the impact of rising food prices on BRICs and the demographic strength could become a liability if food price increase continued unabated also found no mention.

I am a believer of the BRIC economies, but unlike the overweight publicised drivers like growth and productivity I wish to look at the emerging markets differently. And I believe that all the talk about BRICs as strategic investment domains is a bit overplayed if you look at the commodity link and how Russia was a disproportionate gainer in the group not just because of the growth projections from internal macroeconomic factors but because of its high weightage (64 per cent) energy export basket.

There are many mentions found of comparison between return on capital in a large country like China and a small country like New Zealand.

I still did not believe the numbers our workings were throwing up and started crosschecking the returns on BRICs in dollar weighted terms, gold terms and CRB Commodity Index terms. We came to the same result. In actual terms, the Russian stock market grew 3.6 times more than the other BRIC countries since 2000.

In gold weighted terms, the multiple was 9.4 times, and in CRB weighted terms the multiple was at 5 times. In dollar weighted terms, the multiple stood at 4.6 times. This was too much of an evidence for us to discount the underlying commodity boom over emerging market growth factors.

The Shanghai Index in gold terms was still at 2001 highs suggesting how the Chinese iceberg might already be under the global warming pressures.

Another surprise was that India and China were the BRIC underperformers contrary to general market belief. And the Dow Jones actually started underperforming China and India as late as 2006 unlike Russia and Brazil which have broadly outperformed the Dow from Benner's cycle low in 1995.

We at Orpheus believe assumptions are good, but not if they make the forecasts all rosy. BRIC countries might continue to create relative alpha, but the unequivocal stories still belong to gold, agro commodities and possibly assets linked to the extended commodity boom.

Banking on the poor to go to Chinese ghost malls and create internal demand growth factors might just be too simple for a complex forecasting model.

The writer is CEO, Orpheus Capitals, a global alternative research company