By Pooja Thakur and Michael Tsang, Bloomberg
Mumbai/New York: China, India and Russia are losing their allure for stock investors because corporate profits are showing signs of flagging, even as their economies grow at some of the fastest rates in the world.
Stock markets in the three countries are among the 10 worst performers this year. Together with Brazil, they’ve fallen twice as much as developing nations as a whole. In the past five years, each market has at least tripled, helped by an economic boom that exceeds 10 percent a year in China.
Now, growth is stoking inflation and straining production. China yesterday raised interest rates for the third time in 11 months after Premier Wen Jiabao said last week that expansion in the quickest-growing major economy is “unsustainable.” India, the second fastest, is stepping up price controls, and Russia’s energy producers face higher costs to develop oilfields.
“The stock markets grew significantly ahead of the underlying prospects for their economies,” said Peter O’Reilly, who manages $2.4 billion (Rs10,576 crore) at IG International Management in Dublin. “It’s an adjustment to recognize the fact.”
Merrill Lynch & Co., HSBC Holdings Plc and Alfa Bank say the shares may be too pricey given that earnings will probably deteriorate. Profit growth in China will slow next year after reaching 14.8% this year, Merrill Lynch predicts.
Earnings growth at companies in India’s Sensitive index will drop almost 50% in the coming 12 months, HSBC said. Profits for Russian companies will rise just 1% after increasing an average of more than 50% since 2003, Alfa Bank predicts.
O’Reilly said shares in Brazil, the slowest-growing economy of the four, may be the exception, as sliding interest rates spur spending and investment.
The Morgan Stanley Capital International BRIC Index, tracking all four developing countries, fell 1.5% last week to 262.86. MSCI’s Emerging Markets Index, consisting of 25 markets worldwide, dropped 0.7%.
The BRICs acronym was coined in November 2001 by Jim O’Neill, chief economist at Goldman Sachs Group Inc. in New York. He said Brazil, Russia, India and China would join the US and Japan as the biggest economies in the world by 2050, eclipsing most of today’s developed nations.
Russia’s ruble-denominated Micex Index has surged at an average annual rate of 48% for the past five years, the best performance of the four. The Hang Seng China Enterprises Index, tracking shares of mainland companies that international investors can buy and sell freely in Hong Kong, posted average gains of 37%, and India’s Sensitive Index added an average 34%. Brazil’s Bovespa index had an annualized advance of 27% during the same period.
By comparison, the MSCI emerging-markets index rose 26% each year on average, while the Standard & Poor’s 500 Index in the US climbed at a 3.8% rate.
Last year, BRIC-related stock funds garnered a net $18.7 billion. The net inflows equaled 83% of the record $22.4 billion for all emerging markets and the most since Emerging Portfolio Fund Research started compiling figures in 1995.
BRIC markets were the hardest hit during a global sell-off, sparked by a plunge in China’s mainland markets on 27 February, which wiped away $3.3 trillion in value worldwide in a week.
“In the short term, what people want to do is to reduce risk, and these markets are definitely going to be punished,” said Rudolph-Riad Younes, who helps oversee $58 billion as head of international equities at Julius Baer Investment Management in New York. “There’s a lot of hot money in the area. People will sell first and ask questions later.”
The H-share index of Chinese mainland companies has fallen 12% this year as the government struggles to tame an economy that grew 10.7% in 2006, the fastest since 1995. China has expanded 10% or more over the past four years.
Industrial & Commercial Bank of China Ltd and Bank of China Ltd, the nation’s two biggest lenders, led the decline in the share index. The drop this year is the third biggest globally among 90 benchmarks tracked by Bloomberg. Only Qatar and Jamaica have performed worse in local currency terms.
“The biggest problem in China’s economy is that the growth is unstable, imbalanced, uncoordinated and unsustainable,” Wen said at a news conference in Beijing last week. “China’s investment growth is too high, lending growth too fast, liquidity excessive.”
Figures last week showed faster inflation, money supply and loan growth and the People’s Bank of China announced 17 March that it would raise interest rates to 6.39%, the highest in almost eight years, from 6.12%. The decision took effect yesterday and followed increases in August and April.
The central bank has also ordered lenders to set aside more money as reserves five times in the past nine months.
The H share index is valued at 17.2 times forecast earnings, 39% higher than the weekly average of 12.4 times reported earnings since December 2001, available data compiled by Bloomberg showed. Earnings growth at Chinese companies covered by Merrill Lynch will slow to 13.5% in 2008 from this year’s 14.8%, the bank said.
“Slower economic growth will pressure the stock market by damping corporate earnings,” said Zhang Ling, who manages $1.1 billion at ICBC Credit Suisse Asset Management Co. in Beijing.
In India, where the economy is expanding at a 9.2% annual rate, the benchmark Sensitive index, known as the Sensex, has dropped 9.8% this year. The measure has more than quadrupled since the end of 2001.
Shares in India are still expensive relative to earnings, even after this year’s drop. The Sensex is valued at 22.2 times earnings, the third-highest of the world’s 30 biggest markets. Only China’s mainland-listed shares, which most foreigners can’t buy or sell, and those on Japan’s Nikkei 225 Stock Average are more costly. MSCI’s emerging-markets index is at 14 times.
Investor losses have deepened as inflation prompts policy makers to raise borrowing costs and impose price controls on products including cement and steel. Inflation has exceeded the central bank’s 5% threshold each month since September. The Reserve Bank of India boosted interest rates to a four-year high of 7.5% on 31 January, the fifth increase in a year.
Cement makers have agreed to hold prices steady, even if their costs climb, and steelmakers said they will lower the charge for hot-rolled coils by 1.8 percent this month. ACC Ltd, the nation’s largest cement maker, has dropped 38% from its peak on 4 December.
Facing the Truth
Factories and power plants are running close to their limits, the International Monetary Fund said, and capital spending is dragging down earnings growth. Average profit growth among the 30 Sensex members will slow to 17.2% in the financial year ending 31 March 2008, from 30.5% this time, HSBC estimates.
“I don’t think we have reached the bottom yet,” said Sam Mahtani, who helps manage $5 billion in emerging-market equities at Foreign & Colonial Management Ltd in London. “We could see another 10% drop.”
In Russia, the world’s largest energy exporter, the Micex has lost 4.9% this year. It jumped 68% in 2006 as the economy expanded 6.8 percent.
Alfa Bank, Russia’s second-largest privately owned lender, cut its rating on energy producers including OAO Lukoil because spending to develop new oilfields will slow profit growth.
Energy producers, which make up about half the dollar- denominated RTS Index, will report an average 1% growth in earnings before interest, tax, depreciation and amortization, lower than the average of 57% in the past four years, Dmitry Loukashov, an Alfa analyst in Moscow, wrote last week.
“Investors should face the truth: The emerging capex explosion is not a one-off event,” he said.
Higher taxes from crude oil exports may also weigh on earnings. Export and excise taxes at Lukoil, the nation’s biggest energy producer, rose 52% in the third quarter as Russia increased levies and the company boosted shipments abroad.
The stock has dropped 10 percent in dollar terms this year after a 48% jump in 2006.
Falling interest rates in Brazil, Latin America’s largest economy, make the market the best bet of BRIC countries as lower borrowing costs boost lending, said Audrey Kaplan, who manages $2.3 billion at Rochdale Investment Management in New York.
The central bank said it will keep cutting rates after 14 straight reductions since September 2005 that brought borrowing costs to a two-decade low of 12.75%. JPMorgan Chase & Co. last month raised its recommendation for Banco do Brasil, Latin America’s largest bank, citing loan growth.
‘Pound of Flesh’
Brazilian companies’ earnings per share are expected to increase an average 21 percent in the next 12 months, according to Rochdale’s own estimates. For 2006, companies had profit growth of 17.8%, based on the 75% of companies that have already reported, the firm’s figures showed.
That makes Brazil the most attractive among the BRIC markets, according to Kaplan, who has an “overweight” position in the nation’s shares.
Oliver Kratz, Deutsche Asset Management’s head of global emerging-market equities, says there’s no reason to look at this year’s share losses in developing markets because countries including China, India and Russia will dominate industries such as financial services, energy and metals in coming years.
“The emerging markets will claim their proper pound of flesh,” said Kratz, who oversees $5 billion globally at Deutsche Asset. “They have started to do this, and it won’t stop.”
Even so, BlackRock Inc.’s Aldo Roldan, who’s bullish on BRIC markets, said now may not be the best time to buy.
“If you have money to put to work, you need to be patient,” said Roldan, the Plainsboro, New Jersey-based manager of the $17 billion BlackRock Global Allocation Fund. “We would wait for prices to come to us.”
— With reporting by Alexander Ragir, Daniel Hauck, Valentine Ding in New York, William Mauldin in Moscow, Fabio Alves in Brasilia, Shiyin Chen in Singapore and Darren Boey in Hong Kong.