Unloved BRIC stocks may gain as rate rises taper

Steep rate rise cycles in Brazil, India and China are nearing peaks, potentially ending a year-long run of weakness for their equities by tempting investors who reckon domestic demand will allow companies to weather the slowing global economy. This year has seen double-digit losses in Indian and Brazilian stocks and a generally poor performance for MSCI's BRIC index for the second year in a row.
It has dashed hopes that in an uncertain world, the four biggest emerging markets, with fast growth, giant corporations and huge populations would be a relatively safe investment bet.
Russia, where cheap valuations and high oil prices have meant gains, has been the outlier. The other three have pushed the index down 6 percent, while developed markets have lost 1.2 percent and broader emerging markets 3.8 percent. But now, the tide may be set to turn. Hundreds of basis points in rate rises in the three underperforming BRICs are expected to have almost run their course as inflation slows. BRIC valuations are now cheap relative to other markets. Company earnings are seen easing but still being robust.
Julian Thompson, fund manager at AXA Investment Managers, says that because India, China and Brazil embarked on raising rates well before emerging peers, including Russia, they will be among the first to finish.
"Markets don't perform when a tightening cycle is on," Thompson said. "(Brazil, India, China) erred on the side of too much stimulus (during the crisis), it has taken quite a bit of time to take the stimulus out, but we are almost there now." Emerging economies world-wide have been struggling to strike a balance between sustaining growth while stamping on inflation, fuelled by rising wages, high commodity prices and the impact of ultra-loose monetary policies in the West.
An Indian government panel this week said inflation would stay around 9 percent until October and ease after that as food and fuel prices stabilise while most analysts believe Chinese inflation has peaked around 6.4 percent, a three-year high.
Brazil last month hinted rate tightening was almost over and said 12-month inflation would converge to targeted levels in the fourth quarter - 4.5 percent plus or minus 2 percentage points. India has raised interest rates 11 times in this cycle, Brazil eight times and China five times. Russia has done so twice and Indonesia just once. Many big developing nations such as Mexico, Turkey and South Africa are yet to start.
As interest rates rose, cash fled Brazilian, Chinese and Indian equity funds. They saw net outflows of $3.3 billion in the first half of 2011, EPFR Global says, contrasting that picture with Russian stocks which took in $3.1 billion. The test could be India, which investors have shunned since last October as the longest tightening cycle in a decade took hold, threatening a massive hit to growth and corporate profits.
But a Bank of America-Merrill Lynch fund manager survey shows underweight positions on India are falling - the latest poll found 17 percent of fund managers underweight India, down from almost half in May.
Foreigners pumped $2.9 billion into Indian stocks in July, reversing earlier flows, data from the stock regulator shows. Julian Mayo, portfolio manager at Charlemagne Capital, recently went neutral from underweight in India and is also overweight Brazil.
Brazil, China and Russia all trade under 10 times 2011 earnings, while broader emerging markets and developed equities are valued at 11.3 times and 12.7 times respectively. India, always an expensive market, also looks cheap versus its history.
The test now is whether BRIC companies can face the double headwinds of weak global growth and the economic slowdown their central banks have engineered at home. Recent data indicating a world-wide slowdown in factory growth did not spare the BRICs - HSBC's BRIC purchasing managers index fell to a 26-month low.