Tuesday, July 23, 2013

Hitting the BRICs


It was only a few years ago that it was "accepted wisdom" that a healthy allocation to emerging markets stocks was appropriate for most portfolios.

The "BRIC" markets of Brazil, Russia, India and China offered access to strong growth rates, attractive demographics, and mostly reasonable valuations to investors, and so the logic seemed reasonable.

In addition, we were supposed to be in the midst of a commodity "supercycle" as strong demand from the robust emerging markets seemed poised to push material prices on a continuing upward path.

But as so often happens with conventional wisdom, subsequent events have proved the consensus wrong.

The "boring" U.S. market has been the best performer by far over the past three years. Commodity prices, meanwhile, have fallen, and the market valuation of materials companies has declined as well.

The rise in the US markets has been lead by the financial sector. Banks had obviously struggled in the aftermath of the 2008 credit crisis, but since have rebounded strongly with stronger loan growth, an increase in investment banking activity, and greater trading volumes.

The chart above says it all.  While shares in the S&P 500 are up more than +50% since July 2010, emerging markets stocks as represented by the Emerging Markets ETF (EEM) are off roughly -4%.

Here's what the Financial Times wrote this morning:

...At the end of last week the market capitalization of US banks - which exceed $1 trillion for the first time since November 2007 - was more than twice of Bric energy and material companies, which were valued at $432 billion, according to calculations by the Financial Times.

At the start of the year, the value of US banks was just 1.5 times that of the Bric companies.  Bank of America Merrill Lynch last week calculated that the market capitalization of Wells Fargo and JP Morgan of $440 billion exceeded that of every energy and materials company in the Brics ($420 bln).


There are numerous reasons for the events of the past three years.  However, the main culprit behind the struggle of the stocks of the emerging markets is investor fear that the great liquidity wave that has been provided by the world's central banks is about to recede.