Sambanomics and the carnival in Brazil’s Bovespa index
“Brazil is the country of tomorrow and always with be.” General Charles de Gaulle’s indictment of Latin America’s economic superpower was not without historic logic. The legacy of brutal Portuguese colonialism, military dictatorships, currency crises, hyperinflation, sovereign debt death spirals, social unrest, abject poverty and endemic corruption has haunted Brazil. Operation Car Wash, the state contract bid-rigging and bribery scandal that destroyed the political career of President Dilma Rousseff, plunged Brazil into its most draconian economic slump since the Great Depression. Brazil’s GDP contracted by 3.5 per cent in 2015 and 3.4 per cent in 2016. Construction conglomerate Odebrecht defaulted on its US dollarbased bonds, causing Dubai-based NRI clients of a Singapore mass market private bank $24 million in losses. Odebrecht has now settled with Brazil, Switzerland, US and several Latin American countries and must pay $4.6 billion in anticorruption fines.
Financial markets, unlike human brains, extrapolate the future, not obsess about the pain of the recent past — and big money is made when things go from Godawful to just plain awful, the first law of Mattinomics! So early 2016, when Dilma resigned and was replaced by her reformist, pro-business Vice-President Michel Temer, was the time to buy the Bovespa and the Brazil real. The Brazil country fund I use returned 68 per cent for US dollar investors in 2016. Petrobras ADR in New York soared 250 per cent from its lows. Banco Bradesco returned 145 per cent. Obrigado, Brazil, for your stock market, Carnival, samba, Roberto Carlos, Gisele, Pele, lambada and the sheer aesthetic magnificence of Rio de Janeiro.
Brazil will probably deliver 0.5 per cent GDP growth in 2017 but Dr Mark Mobius expects growth to accelerate to five per cent, double the Wall Street consensus, in 2018. The Brazil central bank slashed its benchmark interest rates by an amazing 75 basis points in January, way above the consensus of the sell side herds in both Sao Paulo and Manhattan. Brazil has some of the world’s highest real interest rates and it will not surprise if the central bank in Brasilia cuts the Selic rate by at least 300 basis points in its successive monetary conclaves in 2017. As inflation falls to the central bank target of 4.5 per cent, the Selic rate could fall to nine per cent by Christmas. A reformist government with a stable political vote bank, emergence from inflation, epic central bank rate cuts and a valuation of 12 times forward earnings define Brazil in 2017.
Brazil’s corporates and consumers, burdened with the highest debt service ratios south of the Rio Grande, are the ultimate beneficiaries from this plunge in interest rates and inflation. The finance minister’s pact with Rio de Janeiro state on fiscal discipline is a game changer in Brazil politics. Brazil’s more profligate estados will be subjected to spending freezes, higher pension contributions and a more pressing privatisation agenda. Despite the Bovespa’s fabulous outperformance, the world is still underweight Brazil. None of my friends who own or run major Gulf family offices or merchant banks is long or even au courant with Brazil finance. A pity. They missed one of world finance’s great investment fairy tales of 2016 and 2017.
There are other powerful secular catalysts for the Bovespa too. Emerging markets fund managers are increasing their allocations to Brazil, as Dr Mobius just did. The iron ore and steel rally is a licence to print money for Vale and Gerdau. The consumption binge is bullish for Banco Itau Unibanco, Bradesco and BR Malls. Trump’s threats against Iran, the Saudi/ Russian output cut, the global growth uptick — is all bullish for black gold and the Petrobras ADR even as the company plans to restructure its cost base, restate his financials and slash its debt load. So is it time to expect La Dolce Vita (a multi-year, secular bull market) on the Sao Paulo Bovespa index. Yes Brazil’s Schiller Cape (cyclically adjusted price-earnings) ratio is 9.8 versus 27 in the US, 21 in Mexico and 13 in China.
I have learnt the hard way that Brazil is a rollercoaster market even by emerging markets standards. The Bovespa can and will have violent falls in 2017. The Yellen Fed will turn ugly and hike US dollar interest rates. Chinese demand for iron ore will sag as oversupply kicks in. Pension reform and privatisation will ignite political firestorms in the Senate. A French far right win or a sovereign default in Venezuela or the Bosphrous could ignite emerging markets contagion. My call? Option strategies where my worst-case scenario is to own Bovespa at 48,000.