BRIC (Brazil, Russia, India and China) are not leading the emerging markets so far this year.

Other than being performance leaders in the recent past, we really don’t see why investors would want to link them conceptually. They have quite different economies and resources and are subject to widely different economic, demographic, and geopolitical risk factors.

We continue to be impressed with the strength of Brazil in the face of weakness in India and China, and we are watching with interest the way the Middle East is developing as a frontier market.

Russia is doing better than India and China so far this year, but not as well as Brazil and the Middle East.

We like the apparent insulation of Brazil from the geopolitical turmoil that plaques so many parts of the world, including their historical avoidance of much of the impact of wars in the last century.

The larger Middle East is certainly a hot spot, but the fact is the U.A.E and some other area countries are stable beneficiaries of global petro-dollar money flows. They are booming and diversifying their economies as they grow wealthier. As frontier markets now covered by some public funds, they deserve watching and possible minor allocation.

Russia has risen from ashes in recent years due to its great oil wealth, but as we have pointed out in prior articles, is also an increasingly dangerous place for capital.

China and India simply seem to have been overdone and are giving some back now.

Richard Shaw
QVM Group LLC

So far this year, the Middle East (a frontier market area — proxy TRAMX) is one of the better equity performers, as is Brazil (proxy EWZ).

China (proxy FXI) and India (IFN) are among the worst performing markets so far this year. 

Emerging markets in general (proxy EEM), Russia (proxy RSX), the United States (proxy SPY) and the developed markets of MSCI EAFE (proxy EFA) are in between the best and worst.

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Richard Shaw
QVM Group LLC

Stock markets are just plain ugly right now. 

So far, this is the second worst January for the S&P 500 since 1950 (down 9.0%).  The worst was January 2001 (down 9.2%), which was during the dot com crash. 

Just a few days ago, the S&P was down 10.6% for the month, and based on current overnight Asian stock markets, this January is well positioned to be the single worst January in the past 58 years. 

The chart below tells the story of January S&P 500 returns over the past nearly 6 decades.

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Times are exceptional.  According to Jeremy Siegel on CNN, the Fed has not had an emergency meeting since the dot com crash and a 75 basis point drop in the Fed Funds Rate hasn’t been seen for 25 years.  The sub-prime crisis has few if any equals in terms of size and global impact.  Add that to an apparent global economic slowdown and we are in  unusual if not uncharted territory. 

We believe markets will improve and that excellent buying opportunities will evolve for the brave of heart, but we don’t think right now is the time to be brave. 

The risk of a greater slide is substantial enough that risk control and capital preservation should be given priority over opportunity and capital growth.  We just don’t believe there is enough reason to commit more money to this market in comparison to the reasons to keep powder dry.   

Our position favors risk reduction in these immediate times.

Consider the mid-session market news from Asia, that will impact the open of the U.S. markets in a few hours this morning (January 28th). 

• China down 6.3% (proxy FXI)
• Hong Kong down 4.7% (proxy EWH)
• India down 4.1% (proxy INP)
• Japan down 3.6% (proxy EWJ)
• Singapore down 3.5% (proxy EWS)
• South Korea down 4.1% (proxy EWY)
• Taiwan down 3.3% (proxy EWT)

Actually, the United States has done better than the foreign markets so far this year, after trailing for a few years, as the YTD chart of U.S. (SPY), Foreign Developed (EFA), Foreign Emerging (EEM), China (FXI), India (INP) and Brazil (EWZ) illustrates. India is the biggest loser.

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The following 10-day chart of those same ETFs, shows carnage in India down about 25%, not including being down an additional 4+% in this current overnight session.

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As Falstaff said in Shakespeare’s play Henry the IV, Part One, ”The better part of valour is discretion, in the which better part I have saved my life.”  Not bad advise, we think.

Richard Shaw
QVM Group LLC  

China and India are two tremendously important countries to the future of the world economy. They are both growing rapidly. They account for about 1/3 of the world’s population. Their evolving business enterprises and resource consumption patterns are disruptive to the world business order. They are displacing developed countries in terms of GDP ranking.

However, China and India are not a unit and thinking about them as “CHINDIA” is probably not a good portfolio management idea. They are quite different and should probably be thought of and dealt with separately in a portfolio.

The Chindia concept is a really good marketing concept for fund sponsors seeking various ways to attract investors, but the packaging may not be best for portfolio management purposes.

We believe that China and India are more competitors than partners; each developing from opposite ends of the manufacturing to services spectrum. They are sufficiently different in our view that investors should invest in them through single country funds such as INP (or IIF) for India; or FXI (or CAF) for China.

Buying a single Chindia fund, such as First Trust ISE Chindia (FNI) locks the investor into a particular country allocation (2/3 China and 1/3 India today) which may or may not be ideal and which limits allocation flexibility. We also expect that many investors in Chindia funds do not know the country allocation they are getting.

In practice, we recommend investing in single country funds of any kind only after first establishinga core emerging markets position through a diversified emerging markets index fund such as iShares EEM or Vanguard VWO.

The qualitative arguments for equivalency or difference abound. This article presents objective, quantitative differences that support our argument that the two countries should be dealt with separately.

Some Qualitative Arguments for Difference:

BARRON’s December 24, 2007, Arjun Divecha, Partner, GMO said, “India has benefited hugely from this misperception of Chindia. By linking China and India together, people think that India is in the same league as China when, in fact, it is not.”

Divecha says that India is where China was 15 years ago and is overvalued as a result of being tied so much to China in investor’s thinking.

WikiPedia says, “The economic strengths of these two countries are widely considered complementary - China is perceived to be strong in manufacturing and infrastructure while India is perceived to be strong in services and information technology. China is stronger in hardware while India is stronger in software. China is stronger in physical markets while India is stronger in financial markets. … However, there are also geopolitical differences between China and India that some argue would make this term [Chindia] inappropriate … [including] effects of the Sino-Indian War of 1962 … Their political systems are also vastly different, with China being ruled by a single party and India being the world’s largest democracy.”

Also of great importance, India has a larger problem with terrorist attacks and violent independence movements than China. Pakistan and its vulnerability to Al Quaeda and related movements is a specific risk to India for which there is no comparable risk for China.

QUANTITATIVE PERSPECTIVE:

These data are taken from several sources, including the U.S. Census Department, the CIA Factbook, the United Nations, the International Monetary Fund, the Economist Intelligence Unit and some others.

Country Risks:

India presents lower country risk than China. The Economist ranks the banking risk of India BBB and China B. It ranks the Political risk of India BBB and China B. Both countries are ranked BBB in terms of sovereign debt default risk and currency risk.

Country risk here does not speak to market risks associated with valuation.

Stock Markets:

The market capitalization of the 10 largest companies today in China is $1.8 trillion, whereas the market capitalization of the 10 largest companies in India is only $0.5 trillion.

Similarly, at year-end 2006 the total stock market capitalization of China was $2.4 trillion versus India where it was only $0.8 trillion.

Direct Investment:

China has received more than 10 times the total foreign direct investment as India ($700 billion versus $68 billion).

China has made direct investments abroad that are more than 3 times that of India ($67 billion versus $21 billion).

GDP:

The Chinese GDP expressed in US dollars is three times the Indian GDP ($2.5 trillion versus $0.8 trillion). On a purchasing power parity basis, the Chinese GDP is two and a half times the Indian GDP ($10.2 trillion versus $4.2 trillion).

Growth in per capital GDP has been quite different as the multi-year chart below shows:

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Current Account Balance:

China’s current account balance is positive and growing strongly, while India’s has meandered and recently gone negative, as the chart below shows:

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Energy:

China produces 3 times the electricity of India; more than 4 times the oil; and more than 1.5 times the natural gas.

On the consumption side, China consumes more than twice the oil of India and almost 1.5 times the natural gas.

Other Resource Consumption:

China recently accounted for 29% of global zinc consumption compared to 3.8% for India. China accounted for 25% of world aluminum consumption compared to 2.6% for India. China’s share of global oil consumption was 9% versus 3% by India.

Population:

Approximately 1/3 of the world’s population is either Indian or Chinese, but the populations of China and India are quite different from each other.

India’s population is smaller than China’s, but is growing more rapidly. In 1995, China had nearly 33% more people. By 2005, China had less than 20% more people. By 2025, their populations will be about equal. After that, India will have a larger population.

You can see from the chart below that China and India have quite different population structures.

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India has a population that is growing younger and that will continue to supply young people to the labor force for a long time. China has an aging population that will show labor supply problems without net inflow of migrants.

India today has 6 times the number of people migrating out of the country as China.

China has a 40% lower infant mortality rate than India, and a longer life expectancy.

Labor and Income Distribution:

China and India have roughly equal acreage of arable land, but China has a much smaller portion of its people in agriculture than India (45% versus 60%). China has twice the proportion in industrial jobs (24% versus 12%), and a similar portion in service jobs (31% versus 28%).

China has a lower rate of urban unemployment (4.2% versus 7.8%) and far fewer below the poverty line (10% versus 25%) – although we don’t know how reliable that may be. Both have about 1/3 of total income in the hands of the top 10% of households.

Literacy:

Literacy is dramatically different. Only 61% of Indians over the age of 15 can read and write, while nearly 91% of Chinese over 15 can read and write. The development and therefore economic value of women is higher in China where 86.5% are literate, whereas in India only 47.8% of women are literate.

Religion:

The religious composition is dissimilar.

Hindus account for over 80% of the Indian population, but are negligibly represented in China. Muslims account for over 13% of the India population, but are only about 1% to 2% of the China population. Christians are about 2.3% in India and 3% to 4% in China.

China does not report religious composition as thoroughly as India, but China is greatly influenced by Taoism and Confucianism which have ancient roots there.

India and China do not have similar populations in terms of guiding belief systems.

Languages:

India has numerous regional languages with English as the official government and business language. China has one basic language with regional variations. Mandarin Chinese is the standard language.

Legal system:

India’s legal system is based on English common law while China’s is based on civil law derived from the Soviet Union and continental European legal principles.

India’s judiciary reviews legislation, while China’s legislature retains the right to interpret its laws.

India accepts compulsory International Court of Justice jurisdiction, while China does not.

Political System:

India is a multi-party democracy. China is a single-party controlled state.

Land:

China has 3 times the land area and 2 times the coast line length of India. China has a lower percentage of arable land, but the total acreage of arable land is about the same in both countries.

Natural Resources:

India has the fourth largest coal reserves in the world, while China has the world’s largest hydropower potential.

Transportation and Roadways:

India and China have roughly equal mileage of paved roads, but with 3 times the land area, the density of roads in China is much less than in India. The rail density is closer to parity, but India does have higher rail density than China.

In terms of major airports (those with paved runways over 3,000 meters), China has 58 and India has only 18.

Telecommunications:

India has more than 3 times as many cell phones as China, but China has 7 times as many land lines as India. Combining cell phones and land lines, India has twice as many phones as China, yet a slightly smaller population.

China has more than 2 times as many internet users as India.

Military:

China spends 4.3% of its GDP on its military versus 2.5% by India. In total US dollars, the Chinese military budget is five times the size of the Indian military budget.

* * *

From almost every metric, China and India are very different countries. They are neighbors. They are important and disruptive to the old order of things. They are interesting investments, but they are not unified and “Chindia” is a portfolio concept that could lead to unwarranted conclusions and allocations.

We recommend analyzing and treating India and China as separate portfolio investments.

Richard Shaw
QVM Group LLC

Disclosure: author does not own any named security.

Price change is the ultimate focus of investors, but investing as a forward looking process requires examination of fundamental issues.    One fundamental issue in country analysis is the degree of carbon dependency - principally oil, natural gas and coal.  

Carbon based economies could once assume that carbon for energy and for material was unlimited and that it would always be available.   Not so today.

In World War II control of African and Middle Eastern oil supplies was an important strategic issue that began to put carbon availability as an issue into clearer view.   By the 1970’s an OPEC oil embargo showed that low cost oil was not a total certainty.  In the last few years, both supply and price have come into fierce focus.  Globalization and global growth in standards of living (essentially carbon dependent) have put geologic supplies of liquid carbon fuels into question.  Evolution of terrorism as a new global war with no end in sight has put politically controlled supplies of liquid carbon into flux, along with disruptive price rises.

While there are non-carbon energy alternatives, such as uranium (proxy CCJ), the world is so entrenched in carbon dependency that it is beyond individual investment time frames to consider substitution on a global scale.  While there are enormous coal supplies and technologies to convert coals to liquids and gases (SASOL in South Africa: SSL), these will take many years to implement on a global scale.

There is not necessarily a good or bad level of carbon dependency; however awareness of each country’s carbon dependency could be useful in predicting economic performance under scenarios with varying carbon price levels and available supply. 

Some countries may do better in a carbon starved world, or in a scenario where carbon prices or supplies are in crisis. The table below shows some key carbon dependency facts for major countries and regions.   Let’s think about what implications this data may suggest.

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BRIC (Brazil, Russia, India and China), for example, is anything but a monolith in terms of carbon. 

Russia (proxy TRF) and Brazil (proxy EWZ) are major carbon exporters.  Brazil exports both non-renewable petroleum and renewable alcohol, whereas Russia produces only non-renewable oil and gas.  Russia is in a good carbon situation today, but they are acting recklessly with relationships and they have not shown themselves to be particularly trustworthy in the energy sector — caution is appropriate allocating to Russia. 

China (proxy FXI) is about to be, or may already be, the world’s largest carbon consumer and is working very hard to sustain its carbon supplies to drive its economy and maintain civil order ,which may depend on growth of its economy.  India (proxy INP) is a net carbon consumer, but nowhere near the level of China .  India has built an economy based on exporting brains and services, instead of manufactured goods as China has done. 

Both India and Brazil consume low percentages of world carbon and have low per capita carbon consumption.  That may mean they have lower short term sensitivity to a price or supply crisis, except to the extent that their customers suffer from carbon problems. 

Brazil, as a significant non-renewable and renewable carbon exporter and an economy with low carbon consumption per capita, may be in the best situation to withstand a carbon crisis.  They are also more insulated from geopolitical risk and war than the other BRIC countries.

The United States (proxy SPY) is the granddaddy of carbon addicted countries and is both economically and militarily sensitive to major carbon supply disruptions. On the positive side, the U.S.A has reduced its overall carbon consumption in 2006 over 2005 — unless the reduction is more a sign of reduced manufacturing instead of efficiency.

Japan (proxy EWJ) also showed a reduction in carbon consumption and that is probably an indication of reduced manufacturing — a negative development for them.

Brazil may be in a better overall position than Canada (proxy EWC) or Australia (proxy EWA) in a carbon crisis due to its low consumption level and its significant alcohol export component.  Brazil is not expropriating corporate assets, repudiating contracts, and threatening its neighbors with supply disruption or missiles  as Russia is doing.  Brazil is not producing dangerous products such as poison pet food or toothpaste or defective tires as China has been doing.  Unlike India, Brazil is not next door to a major country (Pakistan) that is in danger of falling under the control of religious radicals that would be dangerously hostile neighbors, and does not have current military border conflicts or a history of war with its neighbors.  Brazil has been a good price performer and is recently the better price performer in the BRIC complex.  For these and other reasons, we overweight our Brazil country allocation.

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Richard Shaw
QVM Group LLC

Disclosure:  Author owns CCJ, EWZ and EWA, mentioned in this article