Don't Get Hit by a Falling BRIC

Albert Einstein once said, "The last thing to collapse is the surface." While that observation is stark, it perfectly describes most things in life, including financial markets.

Think about it this way: If the surface is the last thing to collapse that means the wise course of action is for a prudent person is to look beyond the artificiality of the surface to understand what's underneath. 

Sometimes the structural weakness in a surface area, although not immediately apparent, can be identified by warning signs in other related or interconnected structures. This is probably the case with the global stock market.

Although U.S. stocks (NYSEARCA:SPY) have outperformed global stocks since the start of 2013, surface cracks are appearing, particularly in emerging market stocks (NYSEARCA:VWO).

The Four AmigosIn the economic speak, "BRIC" is an acronym that refers to four countries; Brazil, Russia, India, and China. The BRIC concept was first introduced by Jim O'Neill in a 2001 paper entitled "Building Better Global Economic BRICs."

The BRIC complex is symbolic of economic power shifting away from developed G7 economies to faster growing emerging economies. Never mind rosy forecasts of how BRICs will overtake G7 nations by 2027. What are they doing right now?

BRICs have CRACKSEach of the BRIC nations has their own unique problems. Brazil (NYSEARCA:EWZ) and India (NYSEARCA:INDY) are battling inflation. Russia (NYSEARCA:RSX) is dealing with falling commodity prices (NYSEARCA:DBC) and the impact of Cyprus's crisis on its banking system. What about the "C" in BRIC?

China (NYSEARCA:FXI) has a property bubble. To curb real estate speculation, the city of Beijing has just banned single person households from purchasing more than one residence. The city also raised the minimum down payment for all buyers of second homes.

What about Chinese exports? One must look beyond the surface, as Mr. Einstein hinted, to understand what's really going on. Although Chinese exports have grown since last year (10.5% by some estimates), much of that "growth" is being camouflaged or juiced by currency gambles on yuan appreciation disguised as trade commerce.

The regional economic problems facing BRICs are being exacerbated by larger macro-economic issues. Thus far, the fairyland theory that BRICs can grow exponentially no matter what happens elsewhere isn't coming true.    

What Prices are SayingTo understand this, a person only needs to look at the relative underperformance of emerging market stocks versus developed stocks. It's a bearish trend we've alerted our readers to. In our just released April 2013 ETF Profit Strategy Newsletter, we wrote, "the YTD subpar performance of EM tells us on which side of the trade to be." 

Even before that, our ETF Weekly Pick from March 20 told readers capitalize on this bearish action. The ETF ticker and position we recommended is still open and has already gained 10% since our initial alert.  

In the meantime, the SPDR S&P BRIC 40 ETF (NYSEARCA:BIK) is down -9.52% over the past three months and down -5% over the past year. Currently, BIK is lagging developed stocks (NYSEARCA:EFA) by a significant margin of 12.26% and by 16.48% compared to U.S. stocks going back three months.

Each of the BRIC countries are also included in broad based emerging market stock ETFs like the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) and the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO).

SummaryThe strength or weakness of any stock market can be likened to the thickness of its supporting foundation. If the top layer is cracking, it won't be mortal, so long as the underlying foundation is strong. But if the foundation is built upon sand, then structural cracks or discrepancies are early warning signs. Translation: Ignore the price action of BRICs to your own detriment.

Although economists have tried to dismiss the interconnectivity of financial markets with dangerous concepts like "economic decoupling," we've never bought into these false theories. "Economic decoupling" in an interdependent and interconnected world like ours does not exist. Furthermore, it's a deceptive phrase, comparable to other phony ideas like healthy smoking, loving dictators, and harmless explosives.

Besides keeping tabs on interconnected financial markets, the ETF Profit Strategy Newsletter also tracks market breadth, fundamentals, and key support/resistance levels of major ETF asset classes including stocks, bonds, and commodities.