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BRICs, PITs, And PIGS: Go Ugly

In my research and investing, I stress three things: people, structure and value. I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests, and trade at valuations that are below fair value if not outright cheap. This blog is somewhat aligned with valuation and yet another example of how investing in beaten down, unpopular and ugly markets can lead to better returns. Usually, valuations are low in markets that are not very attractive. Stocks can look very inexpensive, and prices seem to reflect all the negative news, but who knows when the news can get even worse? And it can take even greater will power to stay invested when nobody around you sees your point of view, friends and peers are calling you crazy, and well-educated, respected and slick I-bank analysts and traders are negative (think negative of your point of view?). It’s a lot easier to invest in markets when (where) there’s a lot of good news and the future looks very bright. The problem is that these markets tend to be expensive and future returns tend not to be as good. To contrast these two points, let’s look at two emerging market acronyms – BRICs and PITs that originated about the same time. BRICs stands for Brazil, Russia, India and China. The acronym is attributed to Jim O’Neill in a paper he wrote for Goldman Sachs in November 2001. In it, he argued that these four countries should be included in high-level government groupings such as the “G7” because their size and growth would make them increasingly influential. The acronym came out not long after the tech crash. Wall Street was ripe for a new story, and over the next few years, the term became more popular. Goldman Sachs and many others launched BRIC funds and ETFs. There are now over 200 of them, according to a very expensive database. The term took on a life of its own and the four appear to like the grouping. Just a few months ago the four countries and South Africa formally launched the BRICS Development Bank ( link here ). About the same time BRICs was coined, traders and analysts who survived the late 1990s Asian financial crisis were referring to the ASEAN countries as PITs. The term stood for Philippines, Indonesia and Thailand: the three of the hardest economies and markets. Unlike BRICs, I don’t think anybody has come forward to claim responsibility for it. Calling your home market a degrading term soon after your clients lost money would not likely make one popular. Investing in the four BRIC countries when the phrase was coined would have been smart. The four countries’ headline indexes are up 302% since late 2001 for a CAGR of some 10.5% (return figures are based on equally weighted headline indexes, in USD, dividends not included). In contrast, and despite the acronym’s negative connotation, one would have done considerably better by investing in the three PITs markets than the four BRICs markets. An equally weighted investment in the three grew by 675% over the same time period, which means the PITs investor would have made more than double the money than the BRICs investor. All three PITs indexes did better than even the best performing BRIC index. Thailand, the worst performing PITs country, rose by 229%, a bit more than the best performing BRICs country, which rose by 611% from November 2001 to November 2015. The outperformance of the PITs countries continued after the expression was coined. In July 2006, Goldman Sachs launched a BRIC fund. From launch to close, the fund’s performance was just under 20% and almost exactly in line the four countries’ equally weighted performance. Over the same time period, the three PITs indexes increased by 157%, meaning that one would have made almost eight times more money by investing in the markets that were unloved rather than the ones that were popular by investment funds and advisors. Are PIGS Today’s PITs? PIGS stands for Portugal, Italy, Greece, and Spain and was supposedly coined by traders. These are of the world’s worst performing economies and equity markets since the 2008 global financial crisis. Like PITs it is not a flattering grouping and member countries have reportedly renounced the term (more information on PIGS is here ). I suspect PIGS could be an up-to-date version of PITs. The origins of both are the same and they describe markets that are having problems and are out of favor. Also, like PITs, the countries in the grouping are geographically close and have a lot in common in terms of economic integration, language, and culture. This is more than can be said of BRICs. Except for their size, I don’t really see much that binds them like PITs and PIGS. Since July 2012, the four PIGS headline indexes are up 9% on average. Not very impressive for two-and-a half-years. However, these could be some of the better performing markets in the next 10 to 15 years if similar to the PITs. Back to BRICs Ironically, now may be a good time to consider investing in BRIC equities. Russia has some of the world’s least expensive large companies and is one of my biggest exposures. Brazil is starting to look interesting with its currency down some 40% in the last two years. There are some exciting and inexpensive companies in China, and at 7x PE, the Hang Seng China Enterprise Index does not seem very expensive. Weren’t US equities trading at the same level in the early 1980s just before that market’s 18-year bull run? There’s also a good contrarian signal. Big banks have a good habit of closing operations and products just when things start turning around. HSBC closed its South East Asian equity research offices in 2001 – just before those markets went on a multi-year bull run. Goldman’s closing of its BRICs fund may be a similar signal. Go Ugly This short piece is meant to show that going against the grain and doing what is uncomfortable and unconventional many times leads to higher returns. The best place to find value is typically in ugly sectors and geographies. Are there other places that appear to be ugly and warrant catchy phrases such as PIGS? How’s “RUKs”, for Russia, Ukraine and Kazakhstan, three ex-Soviet countries whose currencies are down and some of the highest interest rates in the world. Or “PCB”, for Peru, Columbia and Brazil, three of the worst performing equity markets this year for US dollar investors? Or “JOBQE”, for Jordan, Oman, Bahrain, Qatar and Egypt which are amongst the world’s least expensive equity markets likely due to the large amount of uncertainty in the Middle East?

The Global X FTSE Portugal 20 ETF: The Case Of The Double Edged Sword

Portugal may have decided to end its EU support too soon. The domestic corporate structure is too diversified, involving many holding companies. The private banking system has remained weakened by a 2014 default. For Europe’s smaller economies, European Union membership, as well as adopting the Euro has been a double edged sword. The idea was for commerce to have the same ease of access similar to the United States of America. Imagine, if you will, what it would be like if goods in Pennsylvania had to make border stops, use passports or visas and pay tariffs as they crossed the New Jersey, then New York, then Connecticut state’s borders! It’s difficult to imagine, but that’s essentially how European nations conducted cross border business before the EEC. Without those ‘technical, legal and bureaucratic barriers’, smaller European economies, such as Portugal, not only had an unimaginably large market for its products, but now had a new employment opportunities for its citizens as well as the potential to expand its manufacturing and financial services base. The ‘icing on the EU cake’ was being able to do away with unstable legacy currencies and adopt the Euro, further leveling the playing field. Indeed, the EU economy expanded pulling along the smaller economies but at an unsustainable rate. When the global credit market collapsed in 2008, the other edge of the sword cut smaller economies to pieces, causing a deep recession, high unemployment and unsustainable debt to GDP ratios, literally putting many governments on the edge of bankruptcy. Since then, the EU has had a slow, uneven recovery. However, having the support of the larger community, many smaller economies have pulled back from the brink of disaster. This is the point: is this the right time to establish a position in the smaller EU economies, such as Portugal? If the investor wished to, there seems to be one available ETF: the Global X FTSE Portugal 20 ETF (NYSEARCA: PGAL ) . The premise for risking your hard earned savings is based on the old Wall Street premise to ” buy low and sell high .” The question is whether the worst is over for Portugal and what the potential is, versus the risk. If a picture is worth a thousand words, the potential for capital appreciation might be interpreted by the fund’s chart since inception in November of 2013. (click to enlarge) The fund closed its first day of trading at $15.05. Within four months the ETF gained 22.8%. At that time, the entire EU economy was struggling with deflation. At the June meeting, ECB President Draghi imposed negative interest rates. Portugal was experiencing a nascent recovery. Portugal’s sovereigns had also recovered. Now able to finance the government on its own to meet its budget the government passed on a scheduled final EU bailout tranche. German Finance Minister Wolfgang Schaeuble noted that: Portugal is now managing without European aid and can stand on its own two feet. That’s a big success. However, within months, a subsidiary of one of Portugal’s major financial institutions missed a debt repayment. Banco Espirito Santo ( OTCPK:BKESY ) , the parent company, had its shares suspended from trading. The Portuguese stock market fell sharply. The default put the entire Portuguese banking system into question. This is an important issue to understand before investing in Portugal through the fund. However, Portugal’s economic stability goes further than the banks. It’s worth examining the fund’s holdings. First, it’s difficult to separate the fund into sectors. For example although classified as a Telecommunications services company, Sonacom (OTC: OTC:SOVTY ) also provides IT services with software and system information services. Sonae Capital (OTC: OTC:SGPMY ) is listed separately as a Consumer Discretionary company and also as a Consumer non-cyclical. Sonae is in the Hospitality and Recreation industry as well as retail food services, superstores, supermarkets, and drug stores. The Sonae brands fall under the management of one holding company. On a larger scale this is not out of the ordinary. However, this seems typical in Portugal’s small economy. Consumer non-cyclical and Discretionary Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Jeronimo Martins OTCPK:JRONY $7.520 1.86% NA 26.97 13.38 23.84 Retail food, distribution; supermarkets, drug stores. Portugal and Poland Sonae SGPMY $2.00 3.30% 38.03 11.46 6.04 61.62 Retail food; superstores, supermarkets, franchise outlets; sporting goods, fashion and electronics Sonae Capital SGPMY $0.101 0.00% 0.00% 150 6.49 42.82 Tourism and Hospitality; resorts, marina, catering, fitness and golf courses Second, the quality of the Financial Services metrics indicates the underlying weakness in the sector. It was difficult to determine any metrics of Banif Banco Internacion do Fuchal (Lisbon: Banif) as it is a privately held company. The bank provides a broad range of banking services from retail to corporate, as well as asset management and insurance. Another of the holdings is Banco Espirto Santo ( OTCPK:BKESF ) , the bank which triggered Portugal’s banking crises shortly after the government had successfully restored its credibility in the sovereign debt market. Financial Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Banco BPI OTCPK:BBSPY $1.46 0.00% 0.00% 82.27 9.54 57.63 Banking Services; corporate, institutional, retail, insurance, credit cards. Subsidiaries in Angola and Mozambique Banco Commercial Portugues OTCPK:BPCGY $2.85 0.00% 0.00% 67.95 11.94 149.69 Privately owned; financial services; asset management, mortgages, consumer credit, insurance Banco Espirito Santo Lisbon: BES $0.613 0.00 0.00 NA NA 237.84 Domestic, corporate and retail banking; credit cards, debit cards, savings accounts, management and insurance One bright spot is the Utilities sector, two of the holdings having respectable yields and one of those has a sustainable payout ratio. Utility Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Energias de Portugal OTC:ELCPF $9.64 5.39% 17.64% of cash flow 11.69 3.62 225.55 Electric and gas in Portugal and Spain Renovaveis OTC:EDRVF $5.22 0.61% 47.56% 34.57 7.25 81.00 Spain based; renewable energy; hydro, wind, solar, tidal and biomass; EU, Brazil, Canada and US Redes Energeticas Naciona OTC:RENZF $0.810 6.14% 14.6% of cash flow 9.52 2.47 206.08 High voltage transmission; electricity; natural gas transmission and storage Portugal’s Basic Materials is concentrated in cements and cement related products. What is a very interesting feature of Portugal’s industrial Sector is its presence in Africa as well as South America, particularly in Brazil. On one hand this is a ‘plus’ as these companies provide their services in regions with a high growth potential like Egypt and South Africa. On the other had the investments in Brazil presents a problem for the fund as Brazil’s economy has recently been brought to a halt, along with a sharp currency devaluation, because of the collapse of commodity prices as well as a political scandal. Basic Materials Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Portucel Lisbon: PTI $2.68 11.26% 104.94 14.42 9.26 47.89 Paper pulp, craft pulp Cimpor-Cimentos De Portugal OTC:CDPGY $0.320 0.55% nil 17.10 1.58 503.71 Cement and aggregate (clinker); ready-mix; Portugal, Egypt, Cape Verde, Angola, Mozembique, South Africa, Brazil, Argentina and Paraguay The Telecom Services are run-of-the-mill as far as the Telecom Sectors go. However it does present another example which lends to the confusion of how some holdings should be classified. Pharol (OTC: OTCPK:PTGCY ) is described as a ‘capital management company’ with a 27% holding interest in Brazilian Telecom Oi (Brazil: OIBR4) . Pharol seems to be more of a hedge fund specializing in the Telecommunications Services Sector, while also investing in other holding companies. Telecom Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business NOS SGPS OTCPK:ZONMY $3.53 1.86% 72.07% 45.12 8.81 98.06 Cable, Satellite, movies, series sports and children programming, mobile and landline voice, data Pharol SGPS PTGCY $0.338 24.10% NA NA NA 0.00 Capital management of Brazilian and Portuguese Telecoms Sonacom SOVTY $0.598 2.13% 30% of cash flow 14.15 12.63 0.94 Telecom mobile and landline; voice, data, television; also some IT software and system information Portugal’s industrials are focused on paper-pulp manufacturing. There are three paper-pulp manufactures in the fund, two of which fit into the Industrials Sector and one in Materials. There’s one major construction company, Mota Engil (OTC: OTC:MTELY ) providing engineering and construction including transportation infrastructure and then managing those projects after completion. Industrials Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business Correios de Portugal OTC:CTTPY $1.295 4.89% NA 18.95 14.70 0.57 Courier services, parcel delivery; financial services, transfers, money orders, digital mail Altri SGPS OTC:ASGSY $0.890 1.68% 74% of cash flow 9.87 6.56 192.25 Paper pulp; generates electricity from waste biomass Semapa-Sociedade de Investimento e Gestao OTC:SEMMY $0.967 2.88% 40.50 14.29 3.18 NA Paper pulp, cement, pre-casts, recycling of cooking oil. Tunisia, Angola, Poland, France Mota Engil SGPS OTC:MTELY $0.445 5.02% 12.8% of cash flow 15.26 2.50 485.19 Engineering, Construction; Environment and Transportation construction and management Lastly, there’s one position in the energy sector, a holding company, GALP Energia (OTC: OTC:GLPEF ) . Galp Energia produces, refines and markets gasoline and petroleum products. Another segment provides oil exploration services in 40 countries. Energy Symbol Market Cap (USD Billions) Yield Payout Ratio P/E Price to Cash flow Total Debt to Equity Primary Business GALP Energia GLPEF $7.06 3.78% N/A N/A 12.74 65.61 Holding Company, energy exploration, production As far as the fund metrics, management fees total 0.61% compared to the industry average of 0.44%. It’s a small fund with about $37.5 million in net assets. Since its November 2013 inception its cumulative return is -26.85% and an average annualized return of -14.70%. The price to earnings for 2015 is 15.37 and price to book 1.35. When referring back to the price history chart, it looks like the fund might be a really good opportunity for a capital appreciation investment. However, upon closer inspection, it was really too far out in front of its potential when it reached its all-time high of $18.48. Further, the private banking sector really needed a restructuring before the government ended the EU restructuring program, as Portugal’s domestic banking crises demonstrates. Some events of the banking crisis are noted on the chart. The price earnings ratio of the holdings weren’t all that bad. Excluding from the count any holding for which the data wasn’t available, and any extreme numbers, it averaged out to 26.20 which doesn’t seem too bad. However, many holdings would not be marginable in US equities markets, in particular, being priced below $5.00 per share. This raises another point. The combination of a low P/E and a low stock price may be an indication of ‘fair value’. Hence, the fund may be close to fair value at this level. It’s unlikely that Portugal’s economy can generate enough investment interest in the foreseeable future in order for the fund to work its way back to the 2014 high. On the bright side, this is a situation where the EU benefits the smaller economies, as it’s a potential safety net for the economy, if it’s necessary. In the current situation, Portugal is now attempting to restructure a weak banking system without direct EU support. An analogy may be made here between Portugal’s economy and the Greek economy. They are in similar straits; however the Greek government has (with difficulties) stuck with the EU bailout program. Portugal may have to reestablish its commitment to the EU restructuring plan. This would be a good fund to ‘bookmark’, and follow the news and events; however, it might not be the right time to establish a position.

Playing With PIIGS: ETFs That Is

There are still pockets of weakness among the PIIGS (Portugal, Ireland, Italy, Greece and Spain),. Not surprisingly, the worst performer of the quintet has been GREK. Over the past two and a half months, yields on the benchmark Italian government bond have fallen about 65 basis points. By Todd Shriber, ETF Professor There are still pockets of weakness among the PIIGS (Portugal, Ireland, Italy, Greece and Spain), the countries previously and some still known as Europe’s problem children, but investors should not outright shun opportunity with the PIIGS. These Little PIIGS Went To Market Entering Tuesday, just two of the five PIIGS’ single-country exchange-traded funds – the iShares MSCI Ireland Capped ETF (NYSEARCA: EIRL ) and the iShares MSCI Italy Capped ETF (NYSEARCA: EWI ) – were higher on a year-to-date basis. Not surprisingly, the worst performer of the quintet has been the Global X FTSE Greece 20 ETF (NYSEARCA: GREK ) , which among other issues, has recently dealt with another market classification demotion and another national election. Although it is down more than 10 percent year-to-date, the iShares MSCI Spain Capped ETF (NYSEARCA: EWP ) is seen as one of the strongest individual PIIGS’ ETFs alongside EIRL, the Ireland ETF. “As for the Spanish ETF, it is valued at around 1.35 times book value, 20 basis points below the global average. The dividend yield of this ETF stands at around 3.8 percent, compared to the global benchmark average of 3.16 percent, according to Morningstar,” reported Barron’s . The European Central Bank’s rendition of quantitative easing, unveiled earlier this year, has reportedly been a boon for commercial real estate deals in Portugal and Spain. Should that trend continue, it could and should benefit EWP, an ETF that allocates nearly 42 percent of its weight to financial services stocks. That is more than two and a half times larger than EWP’s second-largest sector weight. Spanish stocks are also inexpensive. EWP’s P/E ratio is just below 16, implying a discount to the S&P 500 and the EURO STOXX 50 Index. Compelling valuations are one reason why investors have pumped $256.6 million into EWP this year. Over the past two and a half months, yields on the benchmark Italian government bond have fallen about 65 basis points, as some investors have warmed to the notion that lower oil prices and the weak euro will bolster Italian stocks while lifting the eurozone’s third-largest economy out of a recession. EWI, the largest Italy ETF trading in New York, entered Tuesday up 9.2 percent this year. “Gross domestic product is seen expanding 0.9 percent in 2015, up from 0.7 percent projected by the government in April, and then in 2016 more than the 1.3 percent previously forecast,” Bloomberg reported, citing Prime Minister Matteo Renzi. Investors have added $274.1 million to EWI this year. Only GREK has seen larger inflows among the PIIGS single-country ETFs. Another ETF Option For the investor that does not want to make a single-country bet on the PIIGS, the new Deutsche X-trackers MSCI Southern Europe Hedged Equity ETF (NYSEARCA: DBSE ) is an interesting option. DBSE, which debuted last month , is the closest fund on the market today to a true PIIGS ETF. Looking a little closer, DBSE is essentially a combination Spain/Italy ETF, as the countries combine for 95 percent of the fund’s weight; however, that country mix could prove advantageous going forward. Disclaimer: Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.