Investing in BRICS and mortar

Powerful article in the Financial Times.

The writer is not saying that the BRICs will not become really rich and powerful (though obviously nothing is guaranteed), just that there is no reason to believe that those who invest in companies in these countries are going to make any money.

Academic studies have shown there is no positive correlation between GDP growth and stock market returns – if anything the correlation is slightly negative...The reason for this counter-intuitive finding is that you do not buy shares in the statistical construct known as GDP. You buy the shares of real world companies. In immature fast-growing economies, the companies that end up winning the struggle for survival may not even exist yet. That was certainly so in the case of Japan’s economic miracle. In the 1950s there were more than one hundred motorbike companies. The market leader, Tohatsu, was driven out of business by the cut-throat pricing of a flaky upstart called Honda.

Companies in emerging markets are unlikely to generate the kind of cash needed for investment: they will repeatedly raise money on the markets. How does this help those who already hold shares in the company, unless the overall return on investment improves, and is there a real incentive for the companies to do that?

Then comes a ferocious warning about China: the stock market is overvalued, real estate even more so (apartment prices are at 50 times average household income while Japan at the peak of its real estate bubble saw ratios of 12 to 15 time average household income), and investment in fixed assets is 50% of Chinese GDP.

Just as there has never been a bubble that hasn’t burst in the end, so there has never been an investment boom that hasn’t been followed by a bust. If China’s investment-to-GDP ratio were to drop to the levels of 1960s Japan – not an absurd idea, since that is also where it was in China ten years ago – the impact would be catastrophic. China itself would face slump and the mother of all banking crises. A domino reaction would hit the commodity exporters and other emerging economies. The deflationary impact of Chinese overcapacity would be felt everywhere, potentially putting the world trading system at risk. And investors would come to view the “Bric” acronym much as they do “TMT” today.