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.

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

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 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. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. 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.