(an excerpt from a Valor Economico article written by Luciana Seabra and Catherine Vieira).
“How much is it? No, I’ll pass, thanks.” While it is unclear exactly what asset he was referring to, there’s no doubt that the comments of asset manager Luis Stuhlberger to one of his traders during this interview to a certain degree sum up his disposition regarding a good majority of Brazilian assets. If the world is beginning to clear away the clouds and the money is running to riskier investments – which means equities and emerging markets – Brazil could reap some benefits, but not as much as it should. The lack of investment and the exhaustion of consumption-based growth model are beginning to take their toll.
Mr. Stuhlberger sees imbalances which he calls “gator mouths” – a reference to the shape formed on graphs when rapid growth in consumer spending is met with timid investment expansion. Or the difference between the official net public debt and the real net public debt, when the credit extended to state-controlled companies is added.
A bit pessimistic and admittedly suffering from slight “post-holiday depression,” Mr. Stuhlberger met with Valor reporters at his office in Credit Suisse Hedging-Griffo (CSHG). His overall mood is reflected in the respected Verde fund, which has never had so few Brazilian shares – at a mere 16% of the portfolio, against a historical average of 33%. The percentage allocated to shares is the same, but now local companies share space with foreign equities. In 2012, the stock market was the area that brought reason to celebrate to Verde, which yielded 19.55%, while Ibovespa, the benchmark index of the São Paulo Stock Exchange, gained just 7.4% and CDI, the interbank rate that serves as a reference for fixed income across the economy, offered 8.4%. The main highlights of the interview with Mr. Stuhlberger are below:
The global crisis
We are gradually getting over our fear that the world is coming to an end. There is low growth, but that chaotic fear—that public banks and finances are broke and that [European] populations and governments will not approve austerity measures and there will be some type of revolt—is a passing phase that is ending. Nobody talks about this anymore and this fear is not priced in assets. But I don’t think that now Brazil’s problems can be blamed on the Americans, Europeans or the Russians, Arabs or Greeks. Our problems will be our problems. Emerging markets will have a better environment to grow and compete.
[Worldwide] we are in a process of rotation of investments from “bonds to equity,” as investors return to risk. Many people call this the “great rotation.” Both for equities and for the flow to emerging markets. It is money that had been stockpiled for some time amid fears that world was coming to an end. And with the approval of austerity agenda in Europe and now in the USA this discussions on the fiscal cliff, everything is more or less moving. It is a favorable environment, but one obviously cannot guarantee that it will be beneficial forever.
Something’s gotta give
I have a macro outlook that I call “Something’s gotta give,” in reference to the eponymous film. Since gator mouths don’t close on their own, either there will be more inflation or the currency will devalue or there’ll be a problem with public finances. I have several hypotheses to take advantage of this. Only, it’ll be costly. In the sense that, until it happens, you lose money. Another question is whether the world believes that the sole consequence of the collapse of this model is low growth, right? That is: low growth and so what? So what? There is no influence on the currency, on inflation, no collapse of public finances? No one looks at this. I live in my own little world. But now it is a more difficult “play,” because at the same time that I have this pessimistic outlook, it is not on the verge of happening.
I have begun to get perplexed looking at all these points bit, looking at why the model collapsed. The government acts when things go wrong, because no one messes with a winning team. I look at this retail gator mouth versus investment, which is impressive. Even looking at countries such as Korea, Mexico, you’ll see this, but not to the same extent, to lesser degree. It is not sustainable. Investments must come back.
Looking at it from the government’s perspective, since it does not want consumption to drop, it has to make investment grow. To do so, it needs government credit from the BNDES [Brazilian Development Bank], public investment, and that is what it is doing. It needs to create a climate of confidence between the entrepreneur and the government, and I believe that this is not happening. Business people are afraid to invest for several reasons. But the main reason is the moment companies are experiencing right now with the collapse of the model, because since taxes will not decrease, total salaries and wages increase without productivity gains and companies see their margins compressed. Everything takes times, everything costs more and taxes and salaries eat into profitability.
Restoring confidence means instilling a belief that the country has satisfactory conditions to grow. And this is still low. The work that Dilma [Rousseff, the president,] is doing in terms of cutting the tax burden is positive. But this feeling of confidence takes a long time to come. The side effects of the broken model, of growing without taking care of the base, takes times to go away. And like any business that is not doing well, you begin to fix it, but the results take time to materialize. And our loss of competitiveness vis-à-vis other emerging countries has been clear, very quick and very steep. It is not just Dilma’s fault. She inherited a bad legacy and is attempting to fix something that takes a lot of time with a limited budget.
The biggest problem is unlocking growth. So despite a good environment, despite flows to emerging markets and despite a certain global optimism, I am still very skeptical about Brazil. And then you might ask the following: Don’t you think that capital will flow this way, that investments are coming, that there will be buyers for local shares? Yes. The thing is, I think the valuation of companies on the Brazilian stock market is not cheap.
On the stock market, why am I, let’s say skeptical and underweight, I’d say very underweight in Brazil for my standards? Because I do not think that the valuation of good companies is compatible with the risk. Brazil has become a market with value traps on the index [Ibovespa], those companies that no one wants deal with anymore. The power industry is bad; steel is at overcapacity worldwide; state companies are poorly managed; oil is a beast with an enormous, long-term capex that takes time to deliver; construction companies have problems with deliveries and cost increases; and banks have a ROE that is sort of induced by the government to be lower. So that agenda that I spoke of last year, “what is bad for Ibovespa is good for Brazil,” now nobody is interested in these shares and the others that are linked to consumer spending and few other sectors, are no longer cheap for Brazil’s current reality, which is somewhat stagnated.
Price and fundamentals
I am not excessively pessimistic, I just believe that everything is valuation adjusted for risk. At the beginning of 2009, I was buying everything. People asked me: But are you optimistic? “No, I am very pessimistic, but for this price, I’ll buy.” Today, the majority of shares are four times the price I paid in 2009. I am not talking about those on the index, but others like education, retail and consumption.
“All time low”
Today, my investment in stock markets is an average of 33% [of the portfolio], but what was once in Brazil is now spread around. We are buying many things abroad. My investment in Brazilian shares is at an all-time low, which means that today Verde has 16% in these equities. That is the lowest that I can remember and I have the highest investment in shares outside Brazil, with something between 16% and 17%. For the first time, they are balanced, I have half in Brazil and half abroad.
The problem with buying very long-term [Brazilian National Treasury Notes] NTN is the fiscal sustainability over that period. Our debt/GDP ratio is low at 35%. But the fiscal stimulus the federal government gives to state-owned companies created a credit stock of 9% of GDP. This will obviously become debt. Caixa Econômica will certainly need capitalization, one day, BNDES will need it too… There is lost investment that has still not become a debt, but will. Even still, the debt is low compared to the rest of the world. The problem when I analyze scenarios for this type of unbalanced situations is what I call a good picture on a bad negative. If you look at Spain in 2007, the fiscal scenario was marvelous. After the bubble burst, the debt grows exponentially. But I am not saying that this is close to happening.
Zeroing out on local stock exchanges
When I look at Brazil, I say OK, despite the flow, these prices are not worth it. But, in the end, these things are not that simple. Markets always return to the fundamentals, but things get irrational far before your money runs out. So, I think if the party continues without any improvement in Brazil’s fundamentals, I could zero out my holdings on the local market.
No Blue Chips and Photoshop
To tell you the truth, I do not have any blue chips and I can’t buy any. I have significant investments in ten companies … This does not mean that I am long on something and short on others. I have some positions. But I look at this Brazil of right now and I say to myself… “huh, I’m not convinced.” I am biding time to see if the side effects will come quicker than the improvements. Investors are after me every day. Being an asset manager is worse than a woman posing for Playboy. My fund is out there for everyone to see, bare naked and exposed. If I make a mistake, there’s no photoshopping the picture.
Wait and see
I am in that “I’m gonna wait and see” phase. If it goes up a little, I will sell everything [I have in Brazilian shares]. For now, it’s moderately expensive. If there is a really grand party…. I will wait, because I cannot convince myself that despite a better world out there we will not have problems. We might not even have problems, but the prices are not justified. Sometimes it is much easier to catch a trend and say “I’ll go with the crowd.” The decision that I am making, which is very nerve-racking is to say: Well, let’s wait a few months to see where the currency, inflation, GDP and public finances go.
Unpopular at school
My comments are about structural issues and that is where that I have the greatest insights in my life. But it is not easy because you have to go against the tide. But I think I was born that way. I told my 14-year old daughter: I was the most unpopular guy in school. You have to have this in your DNA. I have always been my own man. Let’s see. I hope I am wrong, for Brazil’s sake.