by Carl Delfeld, Global Markets Strategists, The Oxford Club
Wednesday, November 7, 2012: Issue #1900
They say opposites attract, but I’ve noticed, oftentimes, after marriage, opposite partners clash. The problem seems to stem from each trying to get the other to become more like them.
Such is the case with Brazil and China, tied together by economics and politics as members of the BRIC family.
Trade between China and Brazil has exploded over the past decade, but remains very different in terms of what each buys and sells. Bilateral trade has gone from a miniscule $6 billion in 2003 to over $75 billion in 2011. But the trade flows are stunningly different. About 84% of Brazil’s exports to China are basic commodities, while 98% of its imports from China are manufactured goods. This has led to rising trade tensions, as many in Brazil believe that the country has, in effect, a colonial relationship with China.
These numbers highlight what is the starkest difference between these two emerging market giants – their fundamentally different economic strategies for growth.
In China, investment drives about 50% of GDP, while consumption accounts for only one-third of its total economy. Brazil could not be much more different, with investment accounting for only 20% of GDP, but consumption making up 65% of its economy.
Why are the drivers of these two economies so different?
You can start with the fact that Brazil has abundant resources, such as iron ore, that China needs to fuel its manufacturing machine.
In addition, Brazil’s unions have made sure that worker wages have increased steadily over the past decade. And a pretty generous social safety net means that workers tend to spend rather than save their income. On the other hand, China’s aging society and lack of safety net force workers to save a high proportion of earnings, pushing consumption down.
What About Stock Market Performance?
From 2004 to its peak in 2008, total returns, including currency appreciation, made Brazil the darling of global investors, up a staggering 350%, with the Shanghai market just a bit behind, up 328%.
But since then, the results for both have been disappointing.
As you can see from the above chart, over the past five years, the performances of the iShares MSCI Brazil Index (NYSE: EWZ) and the iShares FTSE/Xinhua China 25 Index (NYSE: FXI) have been pretty unimpressive. While the S&P 500 is down 2% during this period, Brazil lost 35% and China is down 40%.
Looks like performance is another thing that China and Brazil have in common.
Ironically, how these two economies and stock markets perform going forward depends on how much they change to be more like the other.
China needs to dramatically increase consumption and pull back its dependence on investment and exports. It also needs a much more transparent and democratic political system.
Brazil need to sharply increase investment, especially in manufacturing and infrastructure, and reduce its bureaucracy and red tape. When Nissan imports iron ore from Brazil to make steel in South Korea, and then ships it back to Brazil to make cars in Brazil… you have a big problem.
If Brazil and China can pull off this personality change, expect another boom to emerge. If not, find another other place to invest your hard-earned money, because growth and market performance will be disappointing.