Appraising the House of BRICs

On this edition of Motley Fool Answers, we go international, looking at the BRIC nations -- Brazil, Russian, India, China -- which were viewed as having huge potential 10 or 15 years ago. (Also mentioned in that category were Turkey, Indonesia, and South Africa, but none with the the level of quite the optimism that surrounded the big four.)

In this segment, Alison Southwick and Robert Brokamp are joined by Joe Magyer, Chief Investment Officer at Lakehouse Capital, and regular contributor to Fool Australia, to talk about the unfulfilled promise of the BRICs, and why they mostly didn't measure up to the economic hype.

A full transcript follows the video.

This podcast was recorded on Sept. 20, 2016

Alison Southwick: Joe Magyer, one of my favorite Fools, and now CIO of Lakehouse Capital, is here.

Joe Magyer: Hello!

Southwick: Yeah!

Robert Brokamp: Joe!

Southwick: If you're a longtime listener of Motley Fool Money or Market Foolery, you'll remember beloved Uncle Joe Magyer. He left us for Australia how many years ago?

Magyer: Three and a half.

Southwick: To go work on Fool.au. But he's visiting this week, so we dragged him into the studio just like every other podcast, because we love him.

Magyer: And now I'm an uncle. Like a real uncle. Which is why I came back for a visit.

Brokamp: Congratulations. You sound legit.

Magyer: Thank you.

Southwick: Why was your nickname Uncle Joe?

Magyer: Because I got into this big, cranky fight with Bill one time about Amazon and Wal-Mart, and it went on for a pretty long time. Chris was like, "You sound like an angry uncle." I was like, "Maybe a cranky uncle." I thought the angry part was unfair.

Southwick: Yeah. Well, we brought you in to give us an appraisal of the BRIC. You are based in Australia. You've turned your back...

Magyer: I am a Mason.

Southwick: You've turned your back on the United States, but I thought you would be able to provide us a unique perspective that's maybe not colored by our jingoist glasses, here, in America. So first some history with the BRIC. Are we ready? I might mess this up, so you guys feel free to chime in whenever.

Brokamp: Sure.

Southwick: The acronym BRIC has been around since 2001. It was coined by Jim O'Neill at Goldman Sachs in a paper titled, "Building Better Global Economic BRICs." Cute, right?

Magyer: Get it?

Southwick: A little bit of a pun.

Brokamp: Yup.

Southwick: The paper proposed that over the coming 10 years, the weight of the BRICs (ha-ha -- he really did say "the weight of the BRICs") will grow and continue to have a significant impact on the global economy, and basically the BRIC was on the brink of something great.

Brokamp: Are you going to tell us what's in the BRIC?

Southwick: So in the BRIC was Brazil, Russia, India, China, sometimes Turkey, sometimes South Africa, and sometimes Indonesia.

Brokamp: Yup.

Magyer: BRICTS.

Brokamp: BRICs-ta-ta-ta.

Southwick: It depends on who you ask. Fast forward 10 years, and I had just started working at The Motley Fool. Joe and I were buddies. Like we probably emailed on a daily basis...

Magyer: Daily...

Southwick: ...because he was so great about doing interviews. I would be like, "CNBC wants to talk about blah," and he'd be like, "I'll do it!" And he would do it. He was the best. So fast forward 10 years. I'm working at The Motley Fool and people were still talking about the promise of the BRIC. Fast forward another five years and that's where we are today.

Magyer: Hm...

Southwick: But where are we, really, Joe?

Magyer: The BRICs kind of got thrown through a window.

Southwick: See? I feel like a cute, little pun maybe got taken a little too far, here. Or Jim O'Neill got trapped by his own pun. But we're going to go through each of the countries. I'll give you bonus points if also want to tackle Turkey, South Africa, or Indonesia, but don't feel like you have to. First up is Brazil. What's up with Brazil these days, Joe?

Magyer: Bad things, unfortunately. They posted some major sporting events and poured a lot of money down the drain. The country is basically dealing with stagflation. Government issues. Stagflation -- they've got high inflation. It's been around 8% to 9% recently. Pretty painful. The economy is not doing well. It's hard for a central bank to get its way out of that. Kind of like the U.S. in, let's say, the late '70s or early '80s. Just not a good time.

Southwick: What about Russia?

Magyer: Also not a good time. They have moved away from being open toward being more closed. Made it more difficult for foreign capital to move in and out. Pretty painful if you're an international investor and you bought based on a BRIC-like thesis. Putin has really tightened the screws on the economy, not invested to take the economy beyond a very oil-based one, and it's coming back to bite them in a very bad way. They're running pretty massive deficits.

Brokamp: Right. As of the first three months of this year, according to CNNMoney, Russia was actually the No. 1 oil producer in the world. When you have an economy so reliant on oil when oil prices just plummeted, you're in a lot of trouble if that's what you're relying on.

Magyer: Mm-hmm.

Southwick: Next up is I -- India.

Magyer: India. So this is a bright spot. The country has been a little slower relative to others, at points, but I like where the country is going over the super long term, and I think Modi is doing a great job of liberalizing the economy in India. However, it's a super, super long-term play. There's a lack of infrastructure. Bureaucracy has run amok. There's a lot to be cut through there. I think there's still a very bright future in the country, but it's going to be a slower burn than China has been.

Southwick: Then that brings us to China.

Magyer: Yeah, so China. Looking back, China has definitely been the star student, or the strongest part of the BRIC, and they have grown at very high rates for a very long time. However, that has been significantly fueled by debt, so between 2007 and 2014 the aggregate debt in the country quadrupled. That's a lot...

Southwick: It sounds like a lot.

Magyer: ...as is the pace at which they've grown their debt load during that time. Of the only four countries that were comparable, three of them were PIGS and the other was Singapore -- not really a group of countries that, overall, you want to be associated with. And roughly speaking, if their debt increased by the same proportion from 2007 to 2014 (again seven years forward), they'd be in the league of where Japan is in terms of debt to GDP, and Japan is choking on debt. They're drowning.

So it's not a sustainable situation. I went to China early last year for a couple of weeks and came away extremely bearish. There's just so much overcapacity in the country. They're building stuff they don't need, because the government's legitimacy is ultimately based on the economy and helping it to grow with steady growth. So the first airport you build in a city makes a lot of sense. The third one -- not a lot of payback on that. That's kind of where they are.

Southwick: And you went to one of the ghost cities, right?

Magyer: We did.

Southwick: What was that like?

Magyer: Ghostly and creepy. We went to the city that's about an hour outside Tianjin. It's a massive city that nobody's heard of, because China is a gigantic country and you just don't keep a scale of how big it is. This ghost city was exactly what you would think. It was loosely a replica of Manhattan. There were hardly any cars or people around. Probably more awkward private security walking around.

I don't know if they were private, or who exactly they worked for, but we took photos and some video and tried to get in and out pretty quickly, because none of those people looked very welcoming. Just a massive overbuild that has no real economic value and is pretty unlikely to come around -- and there are many of them in the country.

Southwick: What happened? Did somebody lump a bunch of countries together where each had their own story ... in its own bad or even worse way? So all those people who were like, Get in the BRIC! Invest in the BRIC! invested in this big bundle of stocks from these countries and each one went sideways for different reasons?

Magyer: Yes, they went sideways for different reasons. Russia and Brazil were both pretty oil-based, and they both got tagged pretty hard. China was a very different thesis, as is India. I think it's really cute and convenient to be able to lump these things in together. In reality, they all had pretty different risk profiles. Different leadership regimes which have all played out very differently.

And it's a good reminder, to their credit, that you do need to think about this in terms of a basket approach. I think anyone who's looking at any of these individual countries and going all in on them is exposing themselves to a lot of risk -- political risk, commodity risk, currency risk. Risk, risk, risk.

I think overall it's nice to have a sleeve of these kinds of countries and emerging markets in your portfolio, but you don't want to go too heavy on that, and you need to take a long-term view that they're going to be really volatile over the short term, for sure, and over the medium term, as well.