Jim O’Neill, the man who coined the term BRIC (Brazil, Russia, India, China), believes that growth story of these countries, which global investors savored for over a decade, is not over yet and the current slowdown is just cyclical.
There has been a lot of disappointment and disenchantment about how the BRIC economies and the BRIC markets are doing. BRIC funds have lost a lot of their assets under management (AUM).
British economist and former chairman of Goldman Sachs Asset Management O’Neill said that some kind of slowdown was expected from these countries as they had grown much faster then anticipated.
At one point of time in past decade China and India were trading at premium on forward price to earnings (P/E) ratio to all the developed markets. “Once you get to that kind of degree of herd mentality, some of the enthusiasm is gone… Now because there is some cyclical economic disappointment, people are giving up hope,” he said.
Explaining his pecking order among BRIC countries O’Neill said that from economy growth point of view he preferred China followed by India Brazil both at second place and Russia at third; in terms of market his priority was Russia due to its cheap valuation.
“I have been looking at markets for thirty odd years and one has to always remember valuations and the valuations of these markets today are the most attractive than they have been for many years. So not at all when I think over the next few years investing in the BRIC countries is again very attractive thing to do,” O’Neil said.
Below is verbatim transcript of O’Neil’s conversation with CNBC-TV18 managing editor Udayan Mukherjee.
Q: This year has not been the best of years for the BRIC, so let me start by asking you about that, why is this disenchantment which has started creeping in about the BRIC markets?
A: First of all I think you do have to distinguish between the BRIC markets and the BRIC economies. Markets and economies do not always go exactly hand in hand.
Secondly, despite that of course the last decade was fantastic for both the BRIC economies and the BRIC markets with the performance of economic growth and the markets vastly surpassing even what I thought. So they have sort of set themselves a very high hurdle. So in some ways, some kind of a slowdown and relative disappointment performance wise compared to the past decade was sort of always going to happen.
Economically China, even though it has slowed, it is doing better than I had assumed for this decade whereas the other three are all doing different degrees of underperformance. That is different than other markets because of course China as an equity market has disappointed the others even though economically, I would argue it is doing better.
Then I think you have to look at each individual country to see what is going on particularly on the economy but to some extent on the markets too.
Q: Do you think global investors are losing interest in the BRICs as a theme perhaps because of China’s slowdown and how poorly Brazil and Russia have done as well?
A: Definitely. Goldman Sachs’ manager who just recently retired has both the BRICs and Next 11 Equity Fund. In the past twelve months, we have seen a lot more flows into the N-11 Fund than the BRICs fund. I think it is representative of broader behaviour of investors. To be honest, it shows not for the first time in my life but many investors, even cautious passive ones are very momentum driven. The fact that the story has lost some of its acceleration and as you touched on in some cases particularly in Brazil and India it had some disappointments, people have lost interest.
Q: How would you rank them now if you had to choose your pecking order in the BRIC, what would it be?
A: Let me just say one of the things before I do that because even though they have lost the fascination of the markets, economically, what is going on with the BRIC countries is still the biggest thing of this generation. I am fond of saying to people that China creates another Greece every twelve and a half weeks, another Cyprus every week, another Spain every year. Actually in the past two years China has created another India. So China on its own is quite remarkable and we do not have the full data to compare yet but for 2011, the BRIC countries created between them another Italy in one year and by 2015, the four then collectively will be bigger than the US. So, we need to keep all of this in perspective.
Q: Your pecking order?
A: My pecking order – I think economically I would have China as number one, because I think it is adjusting very well. It would be a close tussle between India and Brazil as number two and then Russia last number four. Not the same in markets. In terms of markets, I would have Russia number one because it is very cheap. China number two, Brazil number three and India number four. Although all four of them, the way I look at things are now quite cheap and countries of what you said I think for the true forward looking investor over the next five years, this is a fantastic time to be investing in the BRIC markets.
Q: You think the story is not broken, it is just a temporary respite that the BRIC might be going through?
A: I do not think that the story is broken. I think what has happened is because the BRIC story became so strong during the last decade that by the time we hit the global credit crisis since 2008, people were absolutely in love with the BRIC countries. You can see that with China and India in particular they were trading at a premium on a forward price to earnings (P/E) ratio to all the developed markets. At one point both of them were nearly double the US and people could not get enough of the BRIC story. It tends to be the case once you get to that kind of degree of herd mentality, some of the enthusiasm is gone and that is what we are seeing in the past few years. Now because there is some cyclical economic disappointment, people are giving up hope. I have been looking at markets for thirty odd years and one has to always remember valuations and the valuations of these markets today are the most attractive than they have been for many years. I think over the next few years investing in the BRIC countries is again very attractive thing to do.
Q: Not just the Brazil, Russia, India and China (BRIC) but emerging markets in general. Since the start of this year people have been talking about how developed markets will have already started out performing again and that will continue to be a trend which is very different from what we have been hearing for the last couple of years. Do you think that can work out?
A: I don’t think it is actually true because China and Brazil are very big components of emerging market indices, their weakness is dominating what’s happening to the aggregate. You take those out of it and you look at a lot of other important emerging markets, they are actually outperforming everywhere except Japan. Goldman Sachs Asset Management has so called Next Eleven Funds which consists of equity markets and 10 largest populated countries after the BRIC countries including places like Indonesia, Turkey, Philippines and many of these markets are up nearly 20 percent this year. So people say that emerging markets are underperforming developed markets, but it is not true. I think it is very dangerous to generalise about these things.
Q: Since you mentioned Japan, how significant are the ramification of what’s going on in Japan over the last few months for global equity performance?
A: I think this is a huge story. I have often described Japan as existing in happy depression for the past 20 years. The level of gross domestic product (GDP) per capita has continued to creep up although the economy and their markets have been very weak. What we have seen without the Abenomics is they want to have enough of this. The aggressive monetary policy stance they are undertaking in particular is really important for driving asset flows and a weaker yen and a lot of money back into the Japanese stock market. But very importantly the infamous Mrs Watanabe, the Japanese resale investor wants to buy a lot of high yielding foreign markets. So their appetite for high yielding foreign bonds in particular is rising sharply.
Q: Would you say that the implications are largely for liquidity or is it something else because some people including you seem to believe that the recent collapse in gold has a little to do with what’s going on in Japan?
A: It is certainly important liquidity for bond markets, but I think it might be something a little bit more. We forget Japan is still the third largest economy in the world despite what has happened in the past 20 years. I was just there recently and I find myself thinking is this a case where Japanese investors finally starting to invest in real things in Japan and linking it to gold. If you trace back over the past 11-12 years some of the earliest buyers of gold were Japanese investors. Japanese investors don’t have any need for gold when they can buy domestic real estate, domestic equities. Things haven’t been rewarding for them for 20 years. So I suspect, perhaps unconventionally the gold weakness might have something to do with Japan story.
Q: Do you see it persisting? Do you see lower levels in gold?
A: I am in the camp that gold has probably peaked. The past month has demonstrated that gold, even if it ever was a safe haven, clearly isn’t, because it has fell 15 percent in two days. This notion, that it is an easier alternative to investing against easy money everywhere has been just proven. I think gold’s problem is there are far too many people speculating on it that has no natural reason to be owning gold. So I could easily say that USD 200-300 or even USD 400 per ounce decline in the price of gold before it settles. I have not seen for many years’ why it has been truly justified above USD 1,000 an ounce and I wouldn’t be surprised if it go down quite a bit more.
Q: Would you say the same about crude?
A: For separate reasons I had been negative about crude for the past two years. I think there are enormous things going on in the supply and demand dynamics of energy particularly things related to oil. On the supply side, the whole shale gas and shale oil story in the United States is a huge story. In China because they are focusing on what I would call quality of growth as oppose to quantity. It means that demand for energy polluting fuels and conventional fuels is just not going to be the as strong from China this decade as it was in the last. That combination of changing supply and demand dynamics is not good for the price for crude. So I could see crude going down a bit further maybe to USD 80 per barrel or something from where we are today.
Q: Are you surprised by how resilient it has been though because some of these dynamics that you spoke about have been in place for a while but crude has been just sticking around that USD 100 per barrel mark?
A: I wouldn’t say I am surprised. We have this never ending uncertainty in the Middle East and huge fears about escalation of many conflicts in the Middle East and people worrying about the safety of supplies. So I think there is good USD 10 per barrel premium built in for Middle Eastern uncertainty which just in the past few days is showing signs of escalating against. So I am not overly surprised. I am a little bit surprised that many people still talk about the medium to long term outlook being bullish because I think those days are past. The whole bull cycle, not in all but in many commodities has probably peaked.
Q: A lot of people in India have taken quite a bit of heart from the fact that crude started collapsing. Gold collapsed 15 percent in two days, because these things are good for us, but India still remains bottom of the barrel for you in terms of the BRICS ranking. Why are you not optimistic on the margin that falling commodities might help India’s macro out?
A: I do think falling commodity prices is a really good thing for India. So in that sense it is very important that you remind me of that. The reason why I say that in terms of ranking of markets, because India on a forward PE is actually the most expensive and the other three look really cheap, even though India has struggled itself it has not really done poorly like the other three markets. Then as it relates to the economics we have an India that is growing in a 5-6 percent vicinity against the background of an India that if really got its act together could quite easily grow by 10 percent given its demographics. So some of my caution about India relates to the fact that the policymakers seemed to be in almost constant gridlock in trying to unleash supply side reforms and productivity changes which will allow the Indian economy to grow that its long-term potential to me suggests it could do.
Q: Do you sense any major disappointment when you speak to your investors about India? Do they say that we thought so much about this place, but they seem to be missing the boat?
A: I would say from a lot of western investors it is almost a bit more cynical. I always find it quite amusing people who have visited India for the first time and particularly Mumbai are always shocked about what Mumbai is like as a place visually and it immediately scares them off from investing, the whole experience of using Indian infrastructure. So quite a lot of investors often get dragged into investing into India by default there, the fact it did so well drag money in. So the fact that the Indian market had stalled and the Indian economy is slower is actually got a bit of a resign sort of. India needs a lot more decisive government and to try and be more ambitious in terms of introducing economic reforms and it will do better.
Q: What is your view on equities globally this year? There seems to be a bit of disbelief that markets have done so well. These corrections are proving to be more and more elusive. Do you think the bears or the naysayers will continue to be frustrated this year?
A: I have been essentially bullish ever since 2009. I never believed the decline we saw on the back of the great recession in 2008 would lost that long. Equities are really cheap. I spent a lot of time looking at something I call the global equity risk premium which is the so called risk free rates over government bonds. It is really high. When it is really high it is a good time to invest and if you look today as to why it is high it is not only because bond yields are low, it is also because dividend yields are very high and partly due to the indirect consequences of China global growth continues to be okay even despite some of the challenges in the west. Then if you add on top of all of that the extraordinary generosity of western central bank monetary policy it does not surprise me at all that equities are doing well. It will broadly speaking continue.
Q: What is the biggest risk this year you think?
A: The biggest risk this year ironically would probably be if the US economy starts to recover sharply from here, particularly as many people now think it is slowing, so much so that the Federal Reserve board starts to scale back on some of its asset purchases and people start focusing on so called exit strategies. That would be an end of some of the liquidity benefit to markets and that probably would be the biggest risk. A lot of the other things that people talk about, the European crisis, fears of the China hard landing, Middle East these are things that people have all learned to live with to some extent. So probably the biggest risk would be an early exit from monetary policy by the Fed.
Q: From the data that you have been receiving and reading so far would you say that is a high profitability outcome or that phase a still a bit away?
A: I would say that this is why the markets are doing so well. That phase looks quite a way off even though we have had some softening of debts in the States it has not been much, but the most important story is that inflation has been so low that the Federal Reserve Board is making it very clear that they plan to stick with this policy and do not dismiss the possibility of even more easing as we go forward. So I think the notion of them exiting right now seems quite a way off. I would put that as the biggest risk for the year though.
Q: What would you buy though if you were bullish on equities right now? Is it just prudent to be in US and Japan which are the outperforming markets or is there better value elsewhere?
A: There is much better value elsewhere. The US rally has been so big there is not actually a lot of value there. The US you have got momentum and support of policy, but no value. The big value play is Europe and the BRICS and I think for people who really want to buy and hold stocks for a bit longer and really focus on the underlying value in longer term my guess is the better places to invest now are Europe and the BRICS, although they might not give steadier performance in the near-term as the US and Japan, But that is where the real opportunities are. It is very interesting in that regard by the way that the past two weeks the European markets have started to rally sharply on the belief that we are shifting away from some of this austerity and of course the ECB reduced interest rates last week. So I think there is a lot of positive forces out there for many markets, but the ones I think on a 12 month to longer basis will perform the best will be Europe and the BRICS.
Q: Why are commodities doing so poorly though? If the global growth outlook is not too bad then why are things like copper, crude beginning to collapse? Is there a note of dissonance out there?
A: There are two things. You have to look at some commodities for different reasons as we discussed earlier. If you look at crude there is a lot of big supply side changes going on, especially with shale oil and shale gas. With copper some of that is a little bit surprising. But I am guessing it relates to many people starting to acknowledge that China is not going to grow anywhere near 10 percent anymore and probably between 7 and 8 percent and perhaps people have built too high expectations of China growing close to 10 percent for too long. That would be my hunch as to why copper rates are soft.
Q: Do you see this as a grind up kind of a global equity phase or are you predicting in the next couple of years return to a roaring bull market?
A: It is going to be a time till we get a return to the roaring bull market. The scars of 2008 are still very deep. Ironically despite the rally people do not like equities. People buy equities by default and if you look within the markets, particularly within the US market defensives have been leading the rally and that is a sign that people don’t really trust the equity market and they are doing it partly because there is no return elsewhere. Gradually as equity markets keep on performing people will start to rediscover that it is an asset class that has some underlying attributes and value.