December 08, 2012 2634 VIEWS

Friday, December 07, 2012 / ARM Research



•         What is wrong with the BRICs?
•         Move over BRICs, enter the MIST
•         A powerful long term investment theme
•         Nigeria to benefit from global shifts

 The global economic landscape has evolved quite interestingly over the last decade with a paradigm shift the popular appreciation of the primary drivers of global growth. The introduction of the “BRIC” (Brazil, Russia, India and China) acronym in the early 2000’s by Goldman Sachs’ Jim O‘Neil helped change widespread perception of emerging markets, bringing their seemingly dissipated influence on global output into view under one coherent platform.

Under the influence of this insight, investors have undergone gradual reorientation in outlook and have since channeled unprecedented investment capital towards emerging markets, helping reinforce these growth trends. It is estimated that by 2027 the BRIC countries will have overtaken the G7 nations as the major driver of global output .According to the CME group (the world’s largest futures exchange), the BRICs share of global GDP moved from 8% in 2000 to about 25% in 2010 and is on course to reach 40% by 2050.

However, eleven years since the concept emerged, cracks seem to be appearing in the BRIC story with increasing evidence that growth in the four nation bloc is likely to have peaked amid signs of secular deceleration in the years ahead. The timing of this change is also rather inauspicious. A prolonged slowdown in the four-country block poses a fresh threat to a world economy suffering its weakest spell since the end of the 2009 recession, which the BRICs helped ameliorate by contributing about half of the global expansion since 2007. In 2010, the size-weighted average of the real GDP growth in the BRICs was 8.1%, but after slipped to a still healthy 6.5% in 2011, the CME Group estimates BRIC-weighted growth through 2013 at below 5%.


What is wrong with the BRICs?

With increased globalization, which in itself was one of the primary drivers of the emergence of the BRICS, it was inevitable that developed market weaknesses would eventually weigh on the BRICs. Lingering dissolute performance and general lack of economic leadership from the advanced economies has spurred a loss of market confidence, putting brakes on capital flows and directly impacting BRICs dynamism and growth. However, growth challenges among the BRICs have also arisen from a number of largely idiosyncratic structural factors.

Aside from its dependence on exports and investment as drivers of growth which has been hurt by developed market weakness, China faces strictures from its legacy of centralized economic management which has made it less flexible in responding to global threats. In addition China is threatened by the spectre of a looming demographic crisis, both from a prematurely (relative to economic development) aging population and huge gender imbalance, a trait that is also at the centre of floundering performance of many advanced economies.

Russia also faces acute demographic problems, but is also assailed by its failure to sufficiently wean its economy from dependence on commodities, amid softening prices in a weakening global economy as well as deterioration in investor confidence in reliability of an authoritative and increasingly unpredictable regime.  Net capital outflow remains high and as it is expected to hit $70 billion[1] this year down from about $80.5 billion in 2011, but 34% higher than 2010 figure. According to the Russian Central Bank, Outflows have held steady at around 10% of economic output over the past decade. Russia ’s growth is projected to decelerate to 3.6[2]% in 2013 from 4.3% in 2011, according to recent World Bank estimates.

Brazil’s similar reliance (albeit more diversified) on commodities has also linked its outlook more closely to developed markets.  GDP growth slumped to 2.7% in 2011 from  7.5% in 2010 as the combination of weaker commodity demand, penchant for protectionism linked to populist but ultimately unfavorable macro-economic policies, underinvestment in infrastructure (spends only 2% of GDP[3]), and relatively high inflation make it harder for Brazil to adapt to changing global economic conditions.

India does not face the long term demographic constraints of counterparts and is also less exposed to commodity trends than some other members of the block and was somewhat shielded from the worst of the 2007/08 global crisis. Average real GDP growth stood at 7.1[4]% between 2000-2011changing little during the crisis. Nevertheless, an unwieldy political system—exacerbated by relative poverty (India has by far the lowest per capita output among BRICS—which holds macro-economic policy hostage, and dependence on commodity imports has exposed fragilities  in its economy. Like  Brazil, high inflation and interest rates have helped dampen growth which has slowed considerably to 5.3% in Q3 2012[5] – 3rdstraight quarterly decline -  and is projected to decline further to ~3% by 2013. This has dismayed investors and encouraging capital flight, while weakness of the rupee reinforces the inflation cycle.


Move over BRICs, enter the MIST

In the earlier stages of this trend, it was natural to encapsulate the emergence of less advanced economies by characterizing their influence via their largest representatives, hence the rise of the BRICs as a powerful concept. With wider acceptance of this concept in more recent, attention has slowly shifted to underlying performance as a means of capturing the prospects of a broader range of emerging countries. This has led to wider scrutiny of the performance of individual emerging markets in the context of the wider block, and also a more refined understanding of their prospective long term.

Jim O’Neil is credited with creating another acronym to describe a second group of countries that offer exceptional growth potential over the next decade. The “MIST” which stands for Mexico , Indonesia , South Korea and Turkey constitute the next rung of emerging economic powerhouses. These are all members of the G-20 economies, and each represent at least 1% of global GDP. Critically however, quality of economic management and growth prospects among this group of countries is increasingly recognized as being superior to the BRICs. The MIST are largely devoid of debilitating structural problems that plague the large BRICS and owe their success mostly to more robust economic policy and more dynamic and forward looking  long term economic planning. In particular, the MIST economies generally possess a better mix of growth stimuli in terms of favourable demographics, higher productivity, stronger fiscal balance sheets, more favourable balance of payments and more credible fiscal reforms that conduce to a more robust longer term growth outlook than the BRICS.

Mexico has a GDP of $1.15 trillion (2011) which makes it the fourteenth largest economy in the world, is also uniquely placed to pick up the slack in global manufacturing as wages in China rise and reduce its competitiveness in the field of low value-added production. The average manufacturing wage in China surpassed that of Mexico earlier this year, and Mexico also benefits from reduced shipping costs to the critical US market owing to its geographic position and NATO membership. These manufacturing advantages have translated into Mexico claiming an ever-larger slice of the US overall imports pie, accounting to 12% of US total imports last year, up from 10% in 2009. Economists expect Mexico to grow at 3.5% this year, ahead of Brazil 's central bank’s 1.6%[6] estimate. Its benchmark IPC Index (MEXBOL) had risen 12.83% YTD as at the end of November 2012.

Like Mexico , Indonesia ’s large population, youthful demography and relatively high literacy rates is conducive for sustained rapid economic growth.  The Indonesian economy stands out among the MIST countries because of its high levels of domestic consumption. Indonesian consumers account for over 60% of its GDP (compared to China ’s 35%) which, along with persistent current account surpluses, has helped the country weather the Great Recession. Growth has held steady amid the global deceleration.  GDP grew 6.5% in 2011 up from 6.2% the year before. Investors have also taken notice. According to the World Bank, portfolio equity, a measure of net inflows from equity securities into a country, stood at $2.13B in 2011 up from $787 million the year before. Moody's has maintained its investment grade rating for Indonesia 's sovereign debt at Baa3, while Fitch upgraded it to BBB- from BB+. Indonesia 's Jakarta Stock Exchange Composite Index is up 12.26% YTD through end-November.

Turkey's treasured location bridging Europe and Asia is symbolic of its political and economic aspirations. Its $13,466 GDP per capita is below European levels but ahead of all BRICS (except Russia ). With a population of about 75 million and a median age of 26 years, estimates are that ex-Russia, it is poised to become the second largest economy in Europe . One of Turkey 's strengths is a large service sector--which contributed 62% of its GDP in 2011--that sets it apart from most other emerging economies, which rely much more on primary goods and/or commodity exports. Turkey ’s 8.5% GDP growth in 2011 is a slight deceleration from 9.2% in 2010, but is still remarkable considering its strong links to troubled Europe . The iShares MSCI Turkey Index Fund (TUR) seeks to replicate the performance of the MSCI Turkey Investable Market Index. The fund is up 47% YTD.

South Korea, the most dynamic of the MIST economies, boasts a healthy GDP per capita of $27,541, (2011)[7], similar to levels enjoyed by Italy and Spain . 49 million people live in South Korea . Attesting to a startling socio-economic transformation over the past four decades, its highly urbanized and skilled workforce (83% of its population urban areas, while its educational system compares with the best in the world) has long established Korea as a technology and industrial powerhouse fielding such dominant global conglomerates as SAMSUNG, LG and Hyundai. Unemployment is 3.3 %, the lowest in the G-20. Following a pause in mid-2012, output growth is projected to pick up gradually as the OECD estimates output growth of around   4.5% by 2014, led by a rebound in exports as world trade gains momentum.


A powerful long term investment theme

The MIST nations don’t approach the BRICs in economic output--total GDP for the MIST nations was $3.9 trillion last year, less than one third of the $13.5 trillion BRIC economies, vs. $7.3 trillion for China alone. Nevertheless, their much stronger growth prospects may offer more compelling opportunities.  The OECD expects growth for this group to reach 3.9% in 2012 and 4.5% in 2013, and look certain to be more immune to global downturns than their BRIC counterparts over the medium to long term.


The MIST represents the largest markets in Goldman's N-11 Equity Fund, which was launched in February 2011. The fund seeks long-term capital appreciation. Other nations comprising the fund include Bangladesh , Pakistan , Nigeria , Vietnam , Egypt and Philippines .  The Fund invests at least 80% of its net assets in a portfolio of equity investments in companies located in MIST countries. This year alone the fund has outperformed the BRIC fund, posting an impressive 18.31% return YTD as opposed to a 1.5% growth of Goldman’s fund for Brazil , Russia , India and China . Goldman Sachs also reckons investors are increasingly shifting towards the former to position ahead of anticipated resilient growth in the MIST nations.  



The N-11 index is relatively new and as such doesn’t have a long track record. Thus, to obtain longer term comparison of market performance, we assessed the performance of two popular BRIC indices—the MSCI BRIC index and the FTSE BRIC 50 Index—against an the an equal weighted MIST index – comprising of Mexican Bolsa IPC, Jakarta Stock Exchange Composite, KOPSI and MSCI Turkey. On a YTD basis, (without adjusting for fees and other frictions), our model MIST index returned 20.1%, well ahead of the 6.9% and 4.7% of the MSCI BRIC and FTSE BRIC 50 respectively, while Figure also show substantial outperformance over longer periods. 




Nigeria to benefit from global shifts

Amid the shift towards less prominent emerging markets and progressive mainstreaming of this investment theme, we believe Nigerian equities could benefit from this wave of optimism. Certainly, the attractive characteristics (favourable demographic, consumption and growth outlook) it shares with the MIST and positive shifts in macro economic variables sits well with the visibility offered by its inclusion in the N-11and should drive a “growth” valuation upside for Nigerian equities over the near to medium term provided market and economic reforms continue to move in the right direction. We look to see the impact of these trends—already reflected in Nigeria ’s Eurobonds whose yields have compressed ~250bps since its 2011 issue to ~4.2% and consumer goods stocks where earnings multiples have surged into the mid-twenties over the past year, 10-15 ppts higher than broad equity indexes—diffuse into a broader range of Naira assets. On this account, we see significant potential for a valuation rerating for equities in particular over the next few years, with the attendant scope significant performance surge in view of rising prospects for overall earnings growth.

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