Nowadays, while trying to find investment candidates many of them inevitably come from emerging markets. This is not a coincidence. The U.S. market outperformance versus emerging markets has meant that many of the best growth/valuation/ safety compromises are often found outside of the U.S. markets. This outperformance has been extreme:
Source: Yahoo Finance
When considering investment candidates outside of the US markets, especially in countries having their own currencies, a new factor emerges. No longer do you just have to consider the fundamentals of the companies you’re looking into. You also have to consider the fundamentals of the countries where those companies operate in.
This article seeks to do just that. I’ll do a quick appraisal on how some of the most important economic aggregates compare, between Brazil, Russia and China. Here we go…
Source: TradingEconomics.com. China in billion RMB, others in million USD.
All of the countries under consideration run significant trade surpluses. China is the overall champion, though the Russian trade surplus is also massive, especially versus its own population.
China has a more diversified and higher valued added export economy. Russia and Brazil are highly reliant on selling commodities. Russia is particularly exposed to energy exports (crude, natural gas).
Brazil has trouble putting its current account solidly in the black, in spite of a favorable trade balance. This is so because the services balance is unfavorable, as is primary income - due to large external debt and a negative income balance between investments abroad and foreigner's investments in Brazil. The exploding government debt and high interest rates make this harder still.
China and Russia have massively comfortable current accounts.
Russia is showing extremely good fiscal management. It runs a sizable government surplus now, and has been addressing long-term liabilities like pensions and pension age thresholds. Of course, Russia's budget is sensitive to energy prices and volumes, so its revenues are higher risk than Brazil's or China's, thus requiring better management. Still, Russia is by far the best positioned here.
China has seen some deterioration in its fiscal balance.
Brazil is on an unsustainable track, when it comes to government finances.
Again, Russia shows extremely good management and presents extremely low government debt levels. Between its government deficit and government debt levels, Russia is arguably one of the best fiscally managed countries in the world right now. It's not the lowest risk because of energy exposure, though.
On account of its successive and growing fiscal deficits, China has seen an increase in its government debt levels. These levels remain comparatively low, internationally.
As for Brazil, both the trajectory and levels of government debt look unsustainable. Although 77% of GDP in government debt might seem within levels seen elsewhere in developed countries, those countries pay much lower interest rates. At the interest rate levels paid by Brazil, these debt levels ought to be unsustainable.
Inflation looks controlled in all of the countries, in spite of it being higher in Russia and Brazil, and much lower in China.
It looks controlled in Russia and Brazil because the higher inflation was provoked by imported inflation through foreign exchange rate movements. In Russia, there was also an increase in VAT (Value Added Taxes). Both effects look transitory.
However, Brazil's inflation might go out of control. Since its government debt and fiscal deficit both look unsustainable, a course of monetary inflation might take place at any moment.
In spite of showing declining growth, China is still the growth champion.
Russia comes in second. Russia has a large room for higher debt levels as well, which could prompt further growth. On the other hand, Russia has significant energy exposure which can at any moment impact growth. Longer term, Russia's demographics are a headwind for growth.
Brazil's growth is, surprisingly, below Russia's. And this is in spite of massive fiscal stimulus (as seen through the massive fiscal deficit). Were the Brazilian government to show more fiscal restraint in its spending, Brazil would initially see a significant negative impact to growth.
Interest Rates (Benchmark)
Russia has the highest benchmark interest rates, mostly as a function of successive speculative/sanctions attacks on its currency, leading to imported inflation. These now stand at 7.75%. Arguably, as inflation rolls over from the VAT and currency effects, Russia will have room to lower these rates. This could favor growth as well as valuation for Russian assets.
Brazil has a lower, but arguably more deserving of the high level, benchmark rate. I say this because Brazil's finances in general are in a sorry state.
China has a low benchmark rate within this group, but still relatively high internationally.
Interest Rates (10-Year)
Brazil and Russia have very high 10-year interest rates.
Brazil's rates are warranted given the risk imposed by an out-of-control budget and likely unsustainable government debt levels.
Russia's fiscal fundamentals don't warrant such high rates, but the country is under permanent speculative and sanctions pressure. It's arguable that any relief from the permanent sanctions pressure would lead to significantly lower 10-year rates, given the extremely low level of government debt as well as the fiscal surplus Russia now carries.
As for China, its 10-year rates are typical for a developed economy already.
Then There’s Valuation
The fundamentals we talked about give a good picture about where the Brazilian, Russian and Chinese economies stand. They also show the fundamental risks each currency faces. What they don’t give us, is an idea about the relative valuation of the underlying stock markets.
Surely, each of these markets will have a different company mix. Hence, aggregate ratios need to be taken with a grain of salt. Still, it’s useful to look at how aggregate ratios look like, as a proxy for the likelihood of finding cheap opportunities within each market. Here we go.
Brazil: 16x P/E
Russia: 6.0x P/E
China: 8.9x P/E
From the above, we can see that Russia is one of the cheapest markets in the world. This is so in spite of it also having very good country fundamentals as we saw. China also appears significantly cheap, especially taking into account the underlying economic growth.
Brazil can’t be called cheap at 16x Earnings, especially taking into account its high-risk country fundamentals.
Brazil: 2.1x P/BV
Russia: 0.9x P/BV
China: 1.1x P/BV
Same story as with Price/Earnings. Russia and China cheap in relative (versus the World) terms. Brazil expensive.
Brazil: 1.5x P/Sales
Russia: 0.7x P/Sales
China: 0.8x P/Sales
Same story as with Price/Earnings and Price/Book. Russia and China cheap in relative (versus the World) terms. Brazil expensive.
Brazil: 3.1% Dividend Yield
Russia: 6.1% Dividend Yield
China: 3.5% Dividend Yield
In terms of dividend yield, things are closer between Brazil and China. Russia is in a league of its own with an extremely high dividend yield. Moreover, as long as earnings hold up, Russian companies tend to be faithful in paying their dividends. Typically, you’ll find many Russian companies with 3-year dividend policies they stick to.
Fundamentally, Russia has economic fundamentals on a par with the best in the World. It also has the cheapest stock market in the world, simultaneously.
China also has good fundamentals, especially when we take into account its excellent economic growth. These good fundamentals, which are generally better than those found on Western economies, are married to overall low valuations. However, in China when it comes to small/medium enterprises the risk of fraud is extremely high.
Brazil, on the other hand, is expensive both in relative and absolute terms. This is even more so when one considers Brazil has very high-risk country fundamentals. Arguably, Brazil's fiscal and government debt situations are unsustainable.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.