Saturday, September 6, 2014

The "BRICs" Are Uninvestable

We were talking about China this week and about how "China and Russia have the same problems - pervasive corruption, an aging population, higher birthrates among separatist minority groups". I think we have thoroughly established that China is an immense fraud and misallocator of capital.

I have never talked about it on the blog before, but I have business experience in Brazil, and their economy is total chaos. As corrupt as China but more disorganized: siesta culture. As an outsider or public company, you automatically have a higher cost of capital and less profitable business model than local, private competitors because you have not paid the right bribes to avoid taxes and regulation.

I rarely hear anyone seriously propose to invest in India. But many people are also unaware that India is a country that has considered toilets and rejected them, even at great cost to their own health!


Russia is a sad case that I am ambivalent about. Russia has aspects of anti-fragility because it already collapsed to a low order of complexity, and because it is net long and benefits from higher energy and commodity prices. It is just dumb luck that Russia has so much natural gas. If the communists could have sold it all in one slug to the west at any point, they would have. But they couldn't and these resources have now conferred an anti-fragility on Russia.

Unfortunately from an investment perspective, Russia does not have a tradition of harmonious minority ownership of corporations. We will watch and see whether ownership in Russian public companies eventually translates into meaningful economic interest, but right now it doesn't.

I propose a long-term short of the BRICs. Only a very ebullient social mood - and overpriced U.S. securities to match - has caused investors to be interested in abstract (imaginary) claims on BRIC businesses.

The BRIC ETF BKF has a dividend yield of less than two percent. One of the funny things about buy and hold investors is that they choose to ignore some very unpleasant discontinuities in stock index time series. For example, once during the past century you would have lost all of your investment in Chinese companies in a confiscation. How do you account for that? Are you getting paid for that risk with a two percent yield?

17 comments:

Anonymous said...

There are definitely companies from BRICs which will outperform over the long run as well.

SZSE listed CPGs in China, foreign-listed telecoms in Russia, small caps in Brazil, and low beta stocks in India, are a few areas in which you can find solid long-term opportunities.

Emerging markets are more volatile than developed, but both have winners and losers.

If you're looking at short candidates, I would suggest focusing on overpriced stocks in frontier markets, such as Argentina, Nigeria, Pakistan, Sri Lanka, and Vietnam.

As a side note, one can also find corruption (e.g. greedy executives and arcane tax codes), aging populations (baby boomers), and high minority birth rates (such as Latinos in the USA and immigrants in the EU) within developed markets.

CP said...

I didn't say that the BRICs are the only things that are uninvestable!

Anonymous said...

I don't agree that any of the things you mention are "solid long-term opportunities," simply because of the innate deficits of those populations.

China has no legal system! How can you invest in a country with no legal system?

And how can you invest in a country where it wouldn't be safe to visit (and eat) because 90 percent of the population is against sanitation and hygiene?

Anonymous said...

To the comment above: you invest in securities, not in countries. My reading of the first comment is that there are winners and losers in each market segment. A large percentage of Russia-based, NYSE-listed MBT revenues comes from 1.3 billion people and growing in India and I don't think YUM is concerned at all about China's population decreasing.

A company which sells toilet paper would not be a good investment in a country without sewage systems. But what about a company which sells bottled water? Pepsi and Coca Cola are investing more in India than many other countries because nobody wants to drink Indian sewage water.

China has a legal system. Ask any western law firm operating in China. Also ask how much inbound FDI business they deal with.

Anonymous said...

China has no legal system. Ask anyone who has been defrauded by someone in China. (And there are many, many instances - just look at the 2011-2012 U.S.-listed Chinese frauds.)

Have you heard of anyone being able to (a) serve these Chinese fraudsters with process (b) proceed against them in Chinese courts (c) recover a dollar, either way?

CP said...

"The bulging prospectuses used to sell Chinese state companies ahead of their offshore public listings are crammed with information... but the Party's myriad functions, especially control over top personnel, have been airbrushed out altogether. [...] There is a tacit understanding among western intermediaries to play down the Party's role because people understand that it is not going to sell well in the west." (p22)

"Morgan Stanley bankers underwriting the CCB listing were caught by surprise... A number quietly suggested that if the Party wielded such influence in CCB, perhaps its role ought to be declared in the prospectus as well. They were quickly set straight. 'Ultimately, no one was under any illusions that the state controlled the companies,' said an adviser to the deal. 'To get into details about the party committees in a way that was provocative and tendentious was neither productive nor necessary.'"(p52)


Neither productive or necessary for underwriting fees, obviously.

http://www.creditbubblestocks.com/2011/04/thoughts-about-china-review-of-party.html

CP said...

Sure, Pepsi and Coke can make money cash-and-carry selling water. They can make money for U.S. shareholders doing that.

I've simply said that you can only deal with BRICs and other third world countries on a cash-and-carry basis.

I didn't say there aren't a lot of dopes investing in those countries who are going to learn an expensive lesson someday.

Anonymous said...

CP:

From a legal perspective, you are asking about the enforcement of US securities laws. (A) US courts have no jurisdiction within mainland China. (B) Courts in mainland China almost never enforce foreign judgements. (C) It would, therefore, be a waste of time and money to seek recovery within China for violations of US securities laws. A, B, and C do not mean China has no legal system. On the contrary, courts in China enforce Chinese securities laws. Chinese securities laws pertain to securities issued by Chinese companies, including those listed on exchanges within mainland China. (Conversely, Chinese securities laws do not apply to securities that are listed on exchanges outside of mainland China.) When a mainland-listed company commits fraud, shareholders tend to recover their investments.

There are less fraud cases involving mainland-listed securities than US-listed (as well as LSE, TSC, etc listed) securities. US securities laws are lax, fraudsters are innocent until guilty, some get served, but victims are lucky to eventually recover anything either way. China has very stringent listing requirements + oversight, any fraudsters would be guilty unless proven innocent, recieve a death sentence, and victims almost always recover. Some of the largest mainland listed securities frauds are Lantian Group, Macat Optics, and Yinchuan Guangxia. Take a look: they didn't just get an Enron-style slap on the wrist by being sentenced to a minimum security prison sentences for a few years. And, more importantly, shareholders did recover their investments.

If a company in China is listing (or is listed) on an exchange outside of mainland China, ask youself: why is that? Is it because their capital base is outside of China (as in the case of Yahoo owning Alibaba)? And, if so, does the company have operating assets outside of China? Or is it because a company (like Suntech Holdings) can't meet listing requirements in China and can evade regulators by forming corporate shells outside of China? This is a good rule of thumb to apply.

James said...

There are definitely companies from BRICs which will outperform over the long run as well.

SZSE listed CPGs in China, foreign-listed telecoms in Russia, small caps in Brazil, and low beta stocks in India, are a few areas in which you can find solid long-term opportunities.


In a politically unstable country, I don't think it's possible to separate a company's l-t prospects from the country's l-t prospects. Globalization is cyclical, and right now most of the BRICs are as economically open as they've ever been. If they have any kind of political or economic crisis, there's a real risk they'll implement capital controls a la Venezuela or Argentina that make it impossible for you to get your money out. Then your investment will be a long-term opportunity, but not by choice!

James said...

Most of these countries are opportunistic in their respect for foreign investors' property rights. If foreign direct investment is increasing because of globalization, they'll make a pretense of protecting foreign investors in order to compete for foreign investment. If there's an economic crisis that greatly reduces FDI, and it looks unlikely to rebound, then there's no disincentive for them to confiscate your investment or bleed you financially.

Anonymous said...

James, good point about the micro being interlinked with the macro. There are certainly political risks involved. The first comment listed a few frontier markets with overpriced equities as well as accute risks of nationalization, capital controls, etc. Argentinean banks are a good case in point; most have trippled in price since June (when Argentina lost the NML appeal and local investors began avoiding the peso by piling into stocks) despite weakening earnings prospects and inflation / interest rate pressures that are crippling to loan portfolios. Economic crises can also benefit certain stocks, such as manufacturers/commedities who sell/export to foreign markets. Some crises can also be opportune times to buy stocks denominated in foreign currencies because of the exchange rate discounts involved. Bottom line: you can find bargains as well as credit bubble stocks in markets around the world.

Anonymous said...

My impression is that Chinese courts do not hear cases - they are theatrical performances of a predetermined outcome.

Anonymous said...

Anonymous is sound and fury, signifying nothing.

Is his point that we should be buying BRIC equities?

CP said...

Exactly:

"opportunistic in their respect for foreign investors' property rights. If foreign direct investment is increasing because of globalization, they'll make a pretense of protecting foreign investors in order to compete for foreign investment. If there's an economic crisis that greatly reduces FDI, and it looks unlikely to rebound, then there's no disincentive for them to confiscate your investment"

Anonymous said...

Yes, Macbeth, this is clearly the battle with Macduff that you loose in the final act.

There bargains and credit bubble stocks in Brazil, Russia, India, and China.

CP said...

http://www.creditbubblestocks.com/2014/11/young-money-american-and-foreign-power.html

Anonymous said...

He pored over satellite photos of the Soviet Union, counting the ratio of trucks to horse-drawn carts, eventually concluding that rather than the wave of the economic future, the U.S.S.R. represented “Bulgaria with nuclear missiles.”

http://takimag.com/article/in_memoriam_jerry_pournelle/print