Stocks in emerging giants selling cheaply

Bloomberg

Jim O'Neill, chairman of Goldman Sachs Asset Management, speaks at the UC RUSAL President's Forum at The Hong Kong University of Science and Technology, China, on Friday, Oct. 14, 2011. Photographer: Thomas Lee/Bloomberg *** Local Caption ***

Michael Patterson London

The biggest emerging markets are contributing more than ever to the global economy as their proportion of the world stock market shrinks, leaving investors with the widest valuation gap in seven years.

Brazil, Russia, India and China, known as the Bric group, will comprise 20 percent of the world economy this year after growing more than four-fold in the past decade, International Monetary Fund data show (IMF). At the same time, their combined stock-market value has dropped to a three-year low of 16 percent of the total invested in equities.

To Goldman Sachs Asset Management chairman Jim O’Neill, who coined the term Bric in 2001, the 4 percentage point difference makes stocks in these markets irresistible. The last time the gap was this wide, in 2005, the MSCI Bric index rose 53 percent in a year, more than double the gain in the MSCI all-country world index.

“Unless we are seeing a major collapse of those economies, it’s a huge opportunity for investors,” O’Neill said last week. Bric stock markets might double by 2020 as their share of world gross domestic product (GDP) hit about 27 percent, he said.

Combined GDP in the Bric economies will rise to more than $14 trillion (R114 trillion) this year from $2.8 trillion in 2002, according to the IMF. Their equity value has dropped to $7.6 trillion from $9.5 trillion a year ago.

The retreat has pared what was a 180 percent increase in the MSCI Bric index since October 2008 and reflects concern that economic growth is slowing, according to Deutsche Bank emerging market strategist John-Paul Smith.

Falling stock markets suggested the slowdown would worsen because share prices were a leading indicator of economic growth, Marketfield Asset Management chairman Michael Shaoul said. “Equity markets have started to anticipate much more difficult economic times in these countries.”

However, O’Neill expects low interest rates to buoy growth in the Bric countries.

Both the US and EU are keeping interest rates down, while China cut its lending rate last month and Brazil has reduced its benchmark rate seven times since August last year.

MSCI’s Bric index jumped an average 48 percent in the 12 months after policymakers began cutting borrowing costs in 2003, 2005 and 2008.

The emerging-country gauge is valued at 8.9 times earnings, down from an average of 13 over the past three years and less than the ratio of 14 for the MSCI all-country index.

“They are cheap now,” said Princeton University economics professor Burton Malkiel.

Falling valuations for developing nation shares spurred Jonathan Garner, Morgan Stanley’s chief Asia and emerging market strategist at , to recommend “maximum” overweight holdings on June 8. The last two times Garner turned this bullish, in December 2011 and October 2008, the MSCI Bric index climbed at least 8 percent within three months.

“It’s not news that growth in emerging markets has been slow, and our argument is that it is discounted in equity valuations,” he said. “What’s not discounted is the capability of emerging markets to generate GDP acceleration at some point in the second half.” – Bloomberg