Meet the new BRICS’s – The ABC’s of investing in a foreign economy.

With growth expected to be tepid at best here in the United States for the next few years, you would be well served to allocate a portion of your portfolio overseas.  The BRIC’s have been said to be the place to be over the past few years but I have found a few more economies that you might want to consider.  I call them the ABC’s of foreign countries to invest in; Australia, Brazil and Canada.  The big economic revolution of the past decade has been China.  This ‘C’ is somewhat captured in my ABC as China is in the top three of import partners and export partners for the ABC’s, especially Australia.
Portfolio diversification theory is basically the answer to ‘don’t put all your eggs in one basket.’  A well diversified portfolio should have stocks from five to six different sectors.  Studies have shown that once you diversify your portfolio beyond ten sectors you start to lose return in your search to control risk.  A way to diversify past sectors is to diversify your portfolio across countries.

When looking to invest overseas first you have to assess the political risk.  Put your money in Venezuela or Russia (even China) and there is a chance that whomever is in power might get the idea in their head that your company belongs to the government.  This has happened over and over again in the last decade in Venezuela and Bolivia.

Everyone has heard of the BRIC countries; Brazil, Russia, India and China.  Two other countries also to be considered when seeking diversification are Canada and Australia.  Both of these countries are rich in natural resources and both are a Seven-Eleven for a much larger economy.  Canada’s number one trading partner is the huge economy of the United States and China buys more natural resources off of Australia than any other country.

China is an export dominated country and there have been many recent stories about a looming real estate bubble about to burst.  Whether these stories are true or not is less problematic than the fact that being an export dominated economy that still has hundreds of millions of people living under the relative poverty line creates a handful of risks.  Having an export driven economy in a time when all your customers (i.e. United States, Europe, etc…) are going through tough economic times is not good for business.  Throw in a communist government that can turn on a company or sector quickly and combined with a possible real estate bubble and you have a risky economy in which to invest. Do not get me wrong, China is still an economic force but there are many questions as to the authenticity of their economic reports and fragility and volatility of their economy.

Russia has a lot of natural resources but also has a lot of problems of their own.  Recently, Russia suspended wheat exports as fires have consumed a good portion of their wheat producing fields and they no longer have the breadbasket of the Ukraine to rely on for grains.  Russia is another country that while not being communist, still has a lot of the old power structure in place and still functioning to make you think twice about putting dollars up for risk there.  The wheat embargo blocks a flow of export funds into the Russian economy.  Looking at the table below and you see that the market value of traded securities in all the economies discussed in this article have rebounded significantly while Russia’s has continued to go lower.  This implies some problem somewhere.

India has a similar problem to China in that a large portion of their population is living in relative poverty and of these economies discussed, they have the lowest percentage in the labor force by a significant margin.  If you are going to be invested in a foreign country either you need to be very good at picking an individual company or you need to take into account the health of the entire economy – and this includes their poor people.  As unemployment rises in the United States, people will accept less money to get a job.  This dynamic will either staunch the flow of jobs such as IT or phone help centers from migrating overseas and may even bring some of these jobs back home.

The wave of BRIC investing has crested and now with new economic times I think we need to look into the ABC economies; Australia, Brazil and Canada.  The ETF’s for these economies are; EWA, EWZ and EWC respectively.

Here are the economic overviews for each of the ABC countries from The CIA World Factbook website;

Australia's abundant and diverse natural resources attract high levels of foreign investment and include extensive reserves of coal, iron ore, copper, gold, natural gas, uranium, and renewable energy sources. A series of major investments, such as the US$40 billion Gorgon Liquid Natural Gas project, will significantly expand the resources sector. Australia also has a large services sector and is a significant exporter of natural resources, energy, and food. Key tenets of Australia's trade policy include support for open trade and the successful culmination of the Doha Round of multilateral trade negotiations, particularly for agriculture and services. The Australian economy grew for 17 consecutive years before the global financial crisis. Subsequently, the Rudd government introduced a fiscal stimulus package worth over US$50 billion to offset the effect of the slowing world economy, while the Reserve Bank of Australia cut interest rates to historic lows. These policies - and continued demand for commodities, especially from China - helped the Australian economy rebound after just one quarter of negative growth. The economy grew by 1.5% during the first three quarters of 2009 - the best performance in the OECD. Unemployment, originally expected to reach 8-10%, peaked at 5.7% in late 2009 and fell to 5.3% by February 2010. As a result of an improved economy, the budget deficit is expected to peak below 4.2% of GDP and the government could return to budget surpluses as early as 2015. The Australian financial system remained resilient throughout the financial crisis and Australian banks have rebounded. Australia was one of the first advanced economies to raise interest rates - three times since October 2009 - and the government removed the wholesale funding guarantee for financial institutions in March 2010. During 2010, the government will focus on raising Australia's economic productivity, managing the symbiotic, but sometimes tense, economic relationship with China, passing emissions trading legislation, and dealing with other climate-related issues such as drought and devastating bushfires. Australia is engaged in the Trans-Pacific Partnership talks and ongoing free trade agreement negotiations with China and Japan.

Characterized by large and well-developed agricultural, mining, manufacturing, and service sectors, Brazil's economy outweighs that of all other South American countries and Brazil is expanding its presence in world markets. Since 2003, Brazil has steadily improved macroeconomic stability, building up foreign reserves, reducing its debt profile by shifting its debt burden toward real denominated and domestically held instruments, adhering to an inflation target, and committing to fiscal responsibility. In 2008, Brazil became a net external creditor and two ratings agencies awarded investment grade status to its debt. After record growth in 2007 and 2008, the onset of the global financial crisis hit Brazil in September 2008. Brazil's currency and its stock market - Bovespa - saw large swings as foreign investors pulled resources out of Brazil. Brazil experienced two quarters of recession, as global demand for Brazil's commodity-based exports dwindled and external credit dried up. However, Brazil was one of the first emerging markets to begin a recovery. Consumer and investor confidence revived and GDP growth returned to positive in the second quarter, 2009. The Central Bank expects growth of 5% for 2010.

As an affluent, high-tech industrial society in the trillion-dollar class, Canada resembles the US in its market-oriented economic system, pattern of production, and affluent living standards. Since World War II, the impressive growth of the manufacturing, mining, and service sectors has transformed the nation from a largely rural economy into one primarily industrial and urban. The 1989 US-Canada Free Trade Agreement (FTA) and the 1994 North American Free Trade Agreement (NAFTA) (which includes Mexico) touched off a dramatic increase in trade and economic integration with the US, its principal trading partner. Canada enjoys a substantial trade surplus with the US, which absorbs nearly 80% of Canadian exports each year. Canada is the US's largest foreign supplier of energy, including oil, gas, uranium, and electric power. Given its great natural resources, skilled labor force, and modern capital plant, Canada enjoyed solid economic growth from 1993 through 2007. Buffeted by the global economic crisis, the economy dropped into a sharp recession in the final months of 2008, and Ottawa posted its first fiscal deficit in 2009 after 12 years of surplus. Canada's major banks, however, emerged from the financial crisis of 2008-09 among the strongest in the world, owing to the country's tradition of conservative lending practices and strong capitalization.

 

Australia has supertankers from China backed up at sea to load up at the Seven-Eleven.  The economic machine known as China is Australia’s largest business partner in both imports and exports.  A full 17% of Australia’s economy is in exports and over 20% of this business is done with China.  Nearly another 20% of Australia’s export business is with Japan, a large and well established economy that needs natural resources.  The Reserve Bank of Australia has been raising their interest rate and the Australian dollar has been the third best performing currency for the last year.  When a central bank is raising its interest rates this means the economy is heating up.

“The Reserve Bank of Australia, which has led Group of 20 nations in raising borrowing costs six times between October and May, kept interest rates unchanged on Aug. 3 for a third month, partly on concern economic growth may slow in the U.S. and Europe.” (link to full article at Bloomberg.com)

If you are buying a stock you want to buy it on the way up, and not down.  The heating up of Australia’s economy is currently underway.  Most of the business that Australia does with other countries is for coal, iron ore, gold and other natural resources.  Experts say that commodity booms run in cycles as long as 25 years and this current one is less than 10 years old.  One possible weakness the Australian economy has is that as natural resource rich as it is, it has relatively little oil.  Mining is a power intensive business and with little domestic oil production and surrounded by oceans, an energy crunch could dampen production.  I believe the Australian economy will be strong even in bad economic times worldwide, and these may be times the world will see for the next few years.

While the Australian and Canadian economies are established and more stable, the Brazilian economy is an emerging one.  The Brazilian economy used to be one of hyper-inflation and too much debt.  In the last few years Brazil has reduced their debt (relative to GDP) and had its debt moved up to investment grade.  The economic diversity of the Brazilian economy took a big jump when a deep water oil find of as much as eight billion barrels occurred in 2007.  Brazil currently has thirteen billion barrels of proven oil reserves and this eight billion find more than doubled the size of their oil producing potential.  This massive find gave the Brazilian economy an entirely new facet.  Production is not expected until 2012 or 2013 but there will be more work for the oil industry building out the production facilities.  In addition to oil, Brazil has a highly developed ethanol industry with renewable energy providing 46% of their annual energy supply (90% of electricity generation).  High oil prices will only benefit this economy.

Looking at the table below, the one number that glaringly sticks out is that Canada has 5,207 barrels of oil in proven reserves per person.  Luckily, Canada is parked right next to the biggest oil consuming nation on the planet – the United States.  The 178.1 billion barrels of oil Canada has in proven reserves, which makes it the second largest oil reserves by country in the world and even accounting for some of these reserves being in expensive to mine oil sands, means there are at minimum 6 trillion dollars of oil there (profit only $35 a barrel) with an economy of merely 1.3 trillion a year.  The current economic malaise was caused by a seizing up and failure of the mortgage bond market.  Canada’s banks avoided the mortgage meltdown and are some of the strongest in the world right now.  The Canadian economy is diverse, has a strong financial center and is natural resource rich.  The one liability of the Canadian economy is that the United States is their largest customer, accounting for $242 billion of their export and this works out to be 5.5% of the Canadian GDP. 

Once the world economy starts kicking again and oil prices are driven higher, possibly surpassing previous all time highs, Brazil and Canada will be self-sufficient.  As the commodity boom keeps going Australia will prosper.  Countries such as India and China will not do so well when the cost of energy, the key component to any economic engine at their levels of development, soars.  China and India are susceptible to energy prices.  Russia has done decently economically but not of late.  The BRIC’s may still be solid emerging countries to invest in, but you will be well served to keep an eye on Canada and Australia as well.

 

	Australia	Canada	Brazil	Russia	India	China	USA
GDP (official exchange rate, bil)	930.8	1,335	1,449	1,232	1,095	4,814	14,430
per capita GDP	38,800	38,400	10,200	15,100	3,100	6,600	46,400
GDP-real growth rate(2009 est.)%	1	-2.5	-0.2	-7.9	6.5	8.7	-2.4
economic sector composition %
agriculture	4.1	2.3	6.1	4.7	17	10.6	1.2
industy	26	26.4	25.4	34.8	28.2	46.8	21.9
services	70	71.3	68.5	60.5	54.9	42.6	76.9
unemployment rate	5.6	8.3	8.1	8.4	10.7	4.3	9.3
public debt (% of gdp) 2009	17.6	75.4	60	6.3	58	16.9	55.9
public debt (% of gdp) 2008	14.3	64.9	58.6	6.2	54.9	15.6	32.7
inflation rate	1.8	0.3	4.2	11.7	10.9	-0.7	-0.3
Industrial Production growth rate	-4.1	-13	-5.5	-11.9	8.2	9.5	-5.5
electricity production (bil kwh)	0.234	620.7	438.8	1,044	723.8	3,451	4,110
electricity consumption	0.222	536.1	404.3	1,023	568	3,438	3,873
electricity imports	0	55.73	42.06	20.7	0.81	3.842	24.08
electricity exports	0	23.5	2.03	3.10	5.27	0	57.02
oil production (millions of brl/day)	0.5892	3.289	2.572	9.932	0.8788	3.991	9.056
oil consumption	0.9463	2.151	2.460	2.85	2.98	8.2	18.69
oil exports	0.3324	2.421	0.570	4.93	0.739	.0388	1.433
oil imports	0.6872	1.165	0.633	0.048	2.9	4.393	13.47
oil proven reserves (billions brls)	1,500	178,100	12,620	79,000	5,650	16,000	21,320
natural gas prod (bil cu mtrs)	42.33	161.3	10.28	546.8	38.65	82.94	593.4
natural gas consumption	26.59	94.62	18.72	365.7	51.27	87.08	646.6
natural gas exports	22.3	94.67		207.7	0	3.32	30.35
natural gas imports	6.56	16.59	8.44	28.4	12.62	7.46	106.1
natural gas proven reserves	849.5	1,640	365	47,570	1,075	2,265	6,731
exports	160.5	323.4	153	303.4	164.3	1,204	1,046
imports	804	327.2	127.7	191.8	268.4	954.3	1,563
market val traded shares 2007 (b)	1,298	2,187	1,370	1,503	1,819	6,226	19,950
market value traded shares 2008	676	1,002	589	1,322	646	2,794	11,740
market value traded shares 2009	804	1,481	1,338	861	1,227	5,011	17,000*
top export partners	China	USA	China	Nether's	UAE	USA	Canada
	Japan	UK	USA	Italy	USA	HK	Mexico
	S Korea	China	Argentina	Germany	China	Japan	China
top import partners	China	USA	USA	Germany	China	Japan	Canada
	USA	China	China	China	USA	HK	Mexico
	Japan	Mexico	Argentina	Ukraine	S Arabia	S Korea	China
top industries	mining	trans eq	textiles	mining	textiles	mining	div
	ind/trans	chem	shoes	machinery	chem	machinery	div
	Food Pr.	minerals	chem	transport	food pr.	armamnets	div
population (millions)	22.5	34.2	193	142	1,187	1,389	310
labor force (millions)	11.45	18.39	101.7	75.81	467	813.5	154.2
% working	50.89	53.77	52.69	53.39	39.34	58.15	49.74
oil reserves (barrels/person)	66.66	5,207	65.39	556.3	4.76	11.44	68.77

* all number from CIA World Factbook except those with asterisks