Ichiro Suzuki At the outset of the 21st century, Goldman Sachs’ London-based chief economist Jim O’Neal saw the future of up and coming developing economies and coined acronym BRICs that stood for Brazil, Russia, India and China. (South Africa was later added to make it BRICS.) As Mr. O’Neal foresaw correctly, these economies took off shortly, sending their equity markets soaring. A major catalyst turned out to be China’s entry into the World Trade Organization (WTO) that accelerated globalization. China grew at a breakneck rate, voraciously consuming commodities in a wasteful fashion thus enriching countries that produced them. BRICS assets rose fiercely, equities or bonds, creating a spectacular boom in emerging market assets. Emerging markets, or unknown lands, always inspired men and women in the West, dating back to the 15th century. But this boom in the early 21st century appeared bigger than ones in anyone’s memory. The Financial Times ran an article on Mr. O’Neal as “The man who named the future”. An old Wall Street axiom “Brazil is the country of the future, and will always be” seemed dead at last and some Brazilians thought “The future is here.” Investors, professional or retail, were busy buying EM assets of all kinds. Goldman Sachs did a great business, as a forerunner of the boom. By the time the MSCI emerging market index reached its peak on October 31, 2007, there were already signs of a major stress in the U.S. banking system and the financial markets. As soon as the calendar moved into 2008, vicious and relentless sell-off hit the markets around the world. While the instability’s epicenter was the United States, it spread fast and furiously as collateral debt obligations (CDOs) created out of mortgage backed securities of dubious qualities were sold to investors around the world. Emerging markets were no havens in the sell-off. Investors rushed to unload riskier assets. When the global financial crisis was over, emerging markets were never the same again though these economies still posted higher growth rates than the developed world counterparts. While the S&P500 rewrote a pre-crisis high at the end of March 2013, emerging markets struggled way below their October 2007 high. At that time, Mr. O’Neal retired from Goldman Sachs and the firm began to downplay EM assets amid persisting zeal for the markets in developing countries. Behind a wildly successful marketing campaign on BRICS, Goldman Sachs knew that it was institutions (that uphold the system of a country and hence management of the economy) that matter for investment returns, not naked economic growth rates. While EMs have lost luster even among fervent fans since then, developments in the financial markets so far in 2022 are rude awakenings on what matters in investing. Russian dictator Vladimir Putin sent his tanks rolling into Ukraine, obliterating cities and killing civilians, for the purpose of making Ukraine Russia’s vassal state. Alarmed by Putin’s aggression, the West suddenly got united to defend freedom and democracy, doing everything for Ukraine and its President Zelensky, except for sending NATO troops. Harsh economic sanctions were enforced on Russia quickly, sending the ruble to plummet, a stunning 30% fall against the greenback on a single day. The Moscow Stock Exchange is closed and mutual fund companies do not respond to investors’ call for withdrawal of their money from Russian funds. BlackRock is set to write off $17 billion in its investments. Morgan Stanley Capital International (MSCI) and the Financial Times have announced elimination of Russia out of the indices they provide for performance measurement. Are they going to be called BICS from now on? The plight of the Russian market is a precious lesson on ‘institution’ that Goldman Sachs quietly stressed since the departure of Mr. O’Neal. In a democracy this disaster would have been totally avoidable. No one can act like Vladimir Putin in democracy, not even Donald Trump, who idolizes Putin. Were it not for Russia, China would have been the worst performing market this year by a long shot. China’s fall is vicious and indiscriminating. China is on the wrong side of the war as Putin’s precious ally, in an alliance of two largest autocracies. The latest sell-off in mid-March was on an emerging fear of being sanctioned in the event of China’s open actions to help Russia evading sanctions enforced by the West. Fears of sanctions are added to already well-known factors that have been weighing on the market for some time. One is overzealous crackdown on tech entrepreneurs and shareholders for ‘common prosperity’. Another is refusal to respond to reasonable requests by U.S. regulators to allow them to look into the book of the companies that are listed in the NYSE/ Nasdaq. Failure to comply with listing requirements three years in a row automatically disqualifies a company in the U.S markets. This is not anti-Chinese. Quite contrary, stock exchanges have been lax, not enforcing listing principles on Chinese companies so far. In addition, a new COVID outbreak, as soon as the Olympics/ Paralympics are over, is making it worse for fear of large scale lockdowns. Through the end of February, the MSCI China index has registered a mere 1.5% annualized return since its inception at the end of 1992, while the Chinese economy displayed the fastest growth rates on earth during the almost 30 year period. This shows that weak performances from China are not a phenomenon in recent weeks and months but a long-term trend. China has proved that equity market returns can be totally divorced from economic growth rates, while Russia is a showcase of inability to manage the economy directly translated into the market. Once again, it is institutions that matter. In a popular buzzword of the 2020s, institutions can be interpreted as ‘G’ of ESG. Weak governance to uphold the system in a broader sense is detrimental to long-term economic growth, and especially to value creation for shareholders. These countries have their right to hold onto their core value, not having to be aligned with the West. However, when it come to generating financial market returns by winning the trust of shareholders/ bond holders, verdict is already delivered in a very clear cut fashion. Autocracy has lost, a big time. In the U.S., the S&P500 index nearly tripled since the time emerging markets reached their frenzied high in October 31, 2007, whereas EM’s are still distinctly below that level almost 15 years later. The rest of the developed world are somewhere in-between the U.S. and EMs. Even Japan has been posting higher return than China, despite almost non-existent economic growth. Amid global exodus from Chinese equities in mid-March, Xi Jinping made a verbal intervention into the market, saying things that investors wanted to hear. This shows that China’s president still has some interest in saving the market from sinking further. At least it is embarrassing to the Communist Party. Of course, he paid a lip service. The Chinese President is determined to bring private corporations to heel while plundering shareholders. As for other BRICS members, Brazil has suffered acute deceleration of growth in recent years, posting slower growth rates than the U.S. That old Wall Street axiom still stands firmly. The future that some Brazilians saw before the global financial crisis proved to be a mirage. Even worse, the country’s working age population is expected to peak out by the end of this decade. It looks that the country has missed the last bus to get out of the middle income trap. South Africa’s ruling African National Congress (ANC) remains as corrupt and incompetent as ever, totally failing to diversify its economy away from its excessive dependence on mineral resources, sharing the same problem of ‘resource curse’ with Brazil and Russia. All the giants that once dominated the Johannesburg stock exchange fled to London, changing their domicile. While India is considerably less disappointing than others, its growth rates fell below 5% even before the pandemic, and even India is aging faster than earlier forecasts. Though Indian executives dominate Silicon Valley, not much is heard about Indian technology firms, except for Infosys. Prime Minister Modi’s authoritarian tendency does not help, either.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.