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Three Bright Spots for International Investors

Why these countries are uniquely positioned to ride out the economic downturn.

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We think three countries are uniquely advantaged to ride out the current economic downturn. Operating with long-term double surpluses (both on its trade/current account and fiscal budget), and falling interest rates, Brazil, Russia, and Canada are bright spots in an otherwise dreary climate for international investing.

With the major instability we've seen recently in currency exchange rates, we believe a current account surplus offers investors an important source of protection. Countries without a surplus face the constant temptation to devalue their currency. A current account surplus also signals an inherent competitive advantage within a country; essentially, the world has more of a need for the country's products than vice versa. Although running at a short-term budget deficit can actually help rejuvenate an economy, countries that run at a long-term surplus tend to be better off because they can avoid carrying costly debt loads. Countries that are cutting interest rates are also actively trying to stimulate consumer spending, which should help revive economic growth. While cutting rates can lead to higher inflation and a weaker currency, the current account surplus again offers some protection relative to many countries around the world that find themselves cutting rates while also carrying large trade deficits.

Although each of the countries discussed below was hit hard in 2008, and in the short term they might dip into deficit, their long-term economic profiles signal better days ahead.

Stock Market Index: The Bovespa is up 8.26% year to date (all numbers as of March 30, 2009) after falling by 70% in 2008.

Currency: The real has been relatively flat relative to the U.S. dollar year to date after falling 30% in 2008.

Economic Analysis: While Brazil has outperformed virtually every major global stock index thus far in 2009, Brazil's economy is still feeling the heat from slower growth and a worldwide credit crunch. In December, industrial production dropped at a record pace of 14.5% as credit-driven sectors such as autos and housing fell hard. Then, in February the unemployment rate reached 8.5%, the highest level since 2002. This has set the stage for multiple central bank rate cuts, including a 1.5 percentage point cut last month, which was the biggest in five years. Historically, in Brazil, imports are equal to less than 10% of GDP while exports are approximately 12%. Thus, in some ways, the economy is insulated from the issues around the globe, and the country's so-called dependence on China is more myth than reality. The bad news is that commodity price drops destroy sentiment for all emerging markets, and the United States, the country's biggest export partner, is in the midst of an economic meltdown. While on a relative basis, Brazil exports a smaller percentage of its goods to the U.S. than its regional peers, the recent economic shock still pushed Brazil's monthly trade balance into a temporary deficit in January for the first time in six years. Also, credit has started to dry up, as the growth in outstanding loans has fallen for five consecutive months. That said, the trade balance returned to surplus in February and the primary budget balance is over BRL 5 billion. At the end of the day, the country is still posting solid growth numbers; real GDP rose by over 5% last year, and despite the economic shock, the central bank expects the economy to grow by 1.2% this year, and by even more in 2010.

Source: The Ministry of Development, Industry & Foreign Trade

Stocks That Feel It the Most
 Bank Bradesco (BBD)
Banco Bradesco is one of the two largest private banks in Brazil with a network of some 9,000 branches. As such, one of the biggest factors affecting the bank's profitability is Brazil's economic outlook. Loan growth is highly dependent on GDP growth, plus any significant slowdowns are likely to result in high loan losses and lower profitability. In general, Brazil's banks are extremely profitable, largely because of Brazil's high interest rates (called the SELIC--set by the government), which means that the banks have very high net interest margins. Tightening monetary policy (e.g., higher interest rates) can also have a large impact on Brazilian banks' profitability.

 Petrobras (PBR)
Petrobras is Brazil's state-controlled integrated oil and gas company and the country's largest corporation. The company derives the majority of its revenues from Brazil where it was formerly the country's sole supplier of crude oil and continues to dominate the country's oil, refining, and natural gas markets. Petrobras also is subject to government regulation regarding prices of its refined products and exploration of the country's vast offshore oil deposits.


Stock Market Index: The Russian market is up by just over 8% year to date, after falling by over 72% in 2008.

Currency: The ruble has depreciated by over 15% year to date, after falling by nearly 20% in 2008.

Economic Analysis: The country's economy has been ravaged by the 70% drop in the oil price over the past nine months. Oil is the overarching driver of Russia's economic engine: It represents two thirds of the country's export earnings and over 60% of tax revenues. This has triggered a massive downward spiral that has pushed unemployment over 8% (a four-year high), caused industrial output to fall by 16% in January, and has sent disposable income to multiyear lows. It has gotten to the point where some firms have either shaved salaries or completely stopped paying their workers altogether. After posting 10 straight years of GDP growth (and growing by 5.6% in 2008), the Russian Ministry of Economic Development  projects the economy to contract in 2009 by just over 2%. The banking sector in Russia has dealt with some severe liquidity problems that drove the government to initiate a $200 billion rescue plan on top of its $20 billion tax cut. This, combined with the central bank's buying of rubles to slow the currency decline, has shrunk the country's $600 billion in reserves by a third (now down to just under $400 billion). After eight years of surplus, the budget has recently fallen into deficit. Still, this massive reserve cushion puts the country on much better footing than it was a decade ago in its last economic crisis and the country should still post a current account surplus of over $30 billion this year. Also, the current lack of investment in global energy production should lead to some favorable long-term supply/demand dynamics for the country.

Source: The Federal Service of State Statistics

Stocks That Feel It the Most
 Lukoil (LUKOY)
Lukoil is the largest oil producer in Russia, and the second-largest public oil company in the world in terms of proven reserves. The firm represents over 18% of both the country's oil production and refining, and it's one of the largest tax payers to the Russian Federation.

 Vimpel-Communications (VIP) and   Mobile TeleSystems (MBT)
These are the top two mobile telephone carriers in Russia and the Commonwealth of Independent States. The cellular penetration rate in Russia is nearly 130%, and although the number is inflated due to multiple SIM card subscribers, these firms are a great barometer for consumer spending patterns. The dramatic drop-off in disposable income caused us to lower our growth assumptions for these companies.

Stock Market Index: The Canadian market is down 4.36% year to date, after falling by over 35% in 2008.

Currency: The Canadian dollar has depreciated by just over 3.5% year to date, after falling by over 22% in 2008.

Economic Analysis: This is the world's eighth-largest economy. Unfortunately, Canada's prospects are closely tied to those of the United States, as more than 75% of the country's exports are sent to the U.S. The unemployment rate in Canada (also closely tied to the U.S. unemployment rate) is up over 7% and at a four-year high. The central bank recently cut the country's main interest rate to 0.5%, its lowest level ever (now down 350 basis since last February). Canada's real GDP growth in 2008 was 0.7%, but the Bank of Canada projects the economy to contract in 2009 by 1.2% (and by 4.8% in the first quarter) before getting its head back above water in 2010 (gaining 3.8%). Exports of cars, paper, metals, and energy have handcuffed the economy over the past 18 months. On the back of the global recession and the commodity price collapse, Canada fell into a current account deficit last quarter for the first time in a decade. That said, the country hasn't had to resort to government bailouts, the housing market has held up, and none of Canada's major financial institutions have imploded. Despite the economic instability, Canada posted a small budget surplus in January of nearly $30 million.

Stocks That Feel It the Most
 Royal Bank of Canada (RY)
RBC is the largest bank in Canada in terms of total assets and market capitalization. Underpinning the bank's dominant domestic position is more than 1,100 domestic bank branches that allow RBC to attract customers and cross-sell a multitude of complementary products with minimal marginal cost. Overall, this business model allows RBC to generate substantial profits and gives the bank greater stability in difficult times. Nevertheless, demand for loans and other financial products is driven by economic conditions in Canada. Given RBC's size and the general demand for financial products, the bank's aggregate profitability and market valuation are largely driven by general economic conditions in Canada.

BCE is the largest communications company in Canada. The firm provides fixed-line, mobile, Internet, and satellite television services throughout the country. Minutes of use, new subscriber growth, and the average revenue generated per user are all metrics that are influenced by economic growth and disposable income. BCE is also one of the country's biggest employers.

When the international waters get rough, it helps to go back to basics and search for countries with strong fundamentals, such as surpluses and falling interest rates. Although many might look to the markets (and/or stocks) that have lost the most value and project an inevitable bounce, it's important to note that the rebound will be sustainable only if it's backed by solid fundamental economic support. It's no surprise that Brazil, Russia, and Canada have been outperforming their global peers year to date; and although the near-term indicators (unemployment, currency, wage growth) aren't yet pointing up, the countries that fit this profile are better bets to pay off in the long run.

Imari Love does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.