Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 78

From building BRICs to building blocs

The BRICs concept (investing in Brazil, Russia, India and China) captured investors’ imagination like few others. But, above and beyond its acronymic catchiness, did it given us a deeper understanding of the risks and rewards that come with investing in emerging markets, thereby allowing us to profit from this asset class?

I have long had my doubts. These have been confirmed by a close examination of how emerging markets have performed since 2000, rising and falling with the ebb and flow of the commodity tide and, post 2008, the veritable tsunami of central bank-created liquidity that has washed over financial markets.

Time to regroup emerging markets

It’s time to move away from the prism – one might say prison – of the BRICs approach (in its original form, so excluding South Africa) and instead frame the emerging market investing opportunity in terms of country blocs that perform broadly in line with each other as the macro environment evolves. I have identified four main blocs, derived from a 2x2 matrix that:

  • distinguishes between whether a country tends to run a structural current account deficit or surplus, and
  • whether it is primarily a commodity or manufactured goods exporter.MP Table1 050914

    MP Table1 050914

For emerging markets, countries can be assigned as follows:

  • the oil exporters are generally found in the North East (NE) bloc
  • South Africa and the rest of sub-Saharan Africa, South America and Indonesia are in the North West (NW) bloc
  • the maquiladoras (Mexico; most of Eastern Europe and Turkey) plus the Indian sub-continent are in the South West (SW) bloc
  • China-centred East Asia is in the South East (SE) bloc. Recession-hit Czech Republic and Hungary are also recent arrivals to the SE bloc.

It is important to note that this matrix is not unique to emerging markets: the developed world can also be handily described by it. Oil-exporting Norway is in the NE; Australia, Canada and New Zealand are in the NW; the US and the UK are in the SW; and Japan, the Eurozone (which includes emerging markets Greece, Slovakia and Slovenia), Switzerland and Scandinavia are in the SE.

The main distinction lies between the eastern (NE and SE) and western (NW and SW) two blocs. The latter will experience currency depreciation unless they can attract capital inflows to balance their external account; the former are essentially self-financing and are prone to currency appreciation unless their central banks suppress it and instead add to foreign exchange reserves, sometimes via funding sovereign wealth funds. The financial health of the two western blocs is closely correlated to the state of global liquidity.

Northern bloc depends on commodity cycle

A secondary distinction exists between the northern (NW and NE) and southern (SW and SE) two blocs. Over the long term, the former will likely experience relative terms of trade loss versus the latter as commodities see their pricing power versus manufactured goods erode. From the late 1990s, the advent of the commodity supercycle reversed this trend, though since 2011 the normal relationship appears to have resumed, more for metals and coal than for oil and gas. This has weighed on the NW bloc’s prospects more than that of the NE. The financial health of the northern blocs is correlated to the state of commodity markets.

These two distinctions are driven by two dominant players: the United States largely determines the status of global liquidity whilst China determines the health of global commodity markets. (Note that in 2013, China even overtook the US to become the world’s largest oil importer.)

Metaphorically, this means that – to adapt a phrase from the Bard – there are not one but two tides in the affairs of emerging markets: the liquidity tide which is governed by the American moon and the commodity tide which is ruled by the Chinese moon. Over the past decade, these two moons have not waxed and waned in synchrony, so neither has the ebb and flow of these two tides been coordinated.

The prospects of each bloc depends upon interaction between the two tides: for instance, 2011 saw the high tide for commodities coincide with strong liquidity flows arising from the Federal Reserve’s quantitative easing programme being in full flood. This synchronicity was ideal for the NW bloc and both the Brazilian Real and the Australian Dollar reached their peak values during 2011.

Bloc helps to identify risk better than BRIC

Over time, one can observe that risk in emerging markets, mainly represented by volatility, is lowest in the SE bloc and highest in the NW. And, for most of the past decade, the relative positive derived from the current account surplus nature of the NE bloc has outweighed the relative negative arising from its commodity-exporting nature. Net result? The NE bloc has been less risky than the manufactured goods-exporting but deficit-running SW bloc. But in 2014, geopolitics intervened as the fallout from Ukraine weighed on the financial prospects of NE bloc’s largest member, Russia.

Determining where a nation, emerging or developed, fits into this 2 x 2 bloc matrix is far from discovering the Holy Grail of global investing. As evidenced by the Ukraine crisis, specific events can and do impact individual countries, both positively but more often negatively. But for investors, I believe the bloc approach is far more useful than the BRIC approach which, in essence, is but an exercise in sizeism. The irony is that, and this is purely a coincidence, there just happens to be one BRIC in each of the four emerging market blocs.

 

Dr Michael Power is a Strategist with Investec Asset Management. He has 25 years of professional experience working in Africa, the Middle East and the United Kingdom. 

RELATED ARTICLES

Which countries should be classified as emerging market?

banner

Most viewed in recent weeks

Three steps to planning your spending in retirement

What happens when a superannuation expert sets up his own retirement portfolio using decades of knowledge? He finds he can afford much more investment risk in his portfolio than conventional thinking suggests.

Five stock recoveries not hanging on COVID predictions

The focus on predicting the recovery from the pandemic is the wrong emphasis. Better to identify great companies benefitting from market changes over a three- to five-year horizon with or without COVID.

Peak to peak, which LIC managers performed during COVID?

A comprehensive review of dozens of LICs shows how they performed in the crucial 'peak to peak' of COVID. This 14 months tested the mettle and strategies of a sector often under fire, with many strong results.

Finding sustainable dividend stocks on the ASX

There is a small universe of companies on the ASX which are reliable dividend payers over five years, are fairly valued and are classified as ‘negligible’ or ‘low’ on both ESG risk and carbon risk.

Blink and you missed a seismic shift in these stocks

Blink and it happened. If announcements in this sector were made by a producer of iron ore, gas, copper or some new tech, the news would have been splashed across the front pages. Have we witnessed a major change?

How inflation impacts different types of investments

A comprehensive study of the impact of inflation on returns from different assets over the past 120 years. The high returns in recent years are due to low inflation and falling rates but this ‘sweet spot’ is ending.

Latest Updates

Shares

Platinum’s four guiding investment principles

Buying mispriced stocks is often uncomfortable when companies are outside the spotlight and markets are driven by emotions. And it's inescapable that the price paid ultimately determines the end result.

Interviews

Andrew Lockhart on corporate loans as an income alternative

Loans to corporates were the traditional domain of banks, but as investors look for income alternatives to term deposits, funds have combined hundreds of loans into a single structure to create a diversified investment.

Retirement

10 things I learned in my faux-retirement

Pre-retirees should ‘trial run’ their retirements. All those things you want to do - play golf, time with the family, a hobby, write a book - might not be so appealing in reality, but you might discover other benefits.

Retirement

Achieving a sufficient retirement income portfolio

Retirees require a reliable income stream to replace the wages they received when they were working and should focus on the dollar income generated over time rather than the headline yield percentage.

'Wealth of Experience' podcast and ASA webinar on ETFs v LICs

Peter reveals some top stock picks with an emphasis on long-term assets like Sydney Airport, Graham discusses spending in retirement and valuing assets, the key to Amazon, guest Andrew Lockhart and plenty more.

Strategy

Lucy Turnbull’s three lessons on leadership and successful careers

From promoting women to boost culture to taking opportunities as they arise, Lucy Turnbull AO says markets should not drive decision-making and leaders must live and breathe the company's mission and values.

Economy

Are concerns about inflation inflated?

While REITs and some value stocks are considered 'inflation-sensitive' assets, the data provide little support that they are good inflation hedges, and energy stocks and commodities are too volatile. So what works?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.