As a regular watcher of CNBC, I have been noticing for the last two years the many fund managers recommending Emerging Markets stocks (Brazil, in particular) as an alternative to the advanced economy ones. My conclusion is that either they are ignorant and lack the inside knowledge of these alternative markets, or they are serving their own interest (more likely) as they must be heavily invested there or work for one of the emerging markets ETF funds. I guess this is what I like to call the “short CNBC” trade.
First of all, one has to take a look at the comparative performances of these markets. For instance, the graph below shows the Brazilian market index iBovespa (in blue) compared to the S&P500; (in red), for one and two-year time frames.
As seen above, Brazilian Bovespa’s under-performance is 25% (1-year) and 30% (2-years), respectively. If you are a contrarian trader observing bullish sentiment and buy recommendations for a market (Brazil, in this case) that has been under-performing the US benchmark for two years straight (even when the Brazilian economy was doing well), this is a classic sell signal. Anyone who sold short the Brazilian index at anytime in the first semester of 2011 profited nicely.
However, I am not concerned here with the style of trading but with the macro economic fundamentals that will drive this market in 2012. Hence, I will discuss briefly the three inter-related macro drivers here: the Brazilian Real (BRL), the inflation, and interest rates.
The BRL has been on a devaluation trajectory for the last three months. This week the dollar closed at around BR$1,90 and some say there is further room for devaluation. Considering it was hovering at 1,55 five months ago, it is safe to say that a lot of people lost a lot of money in a very short time. For instance, if you were a fixed income investor seeking high yield in BRL denominated bond, you would have lost 20% of your investment, not considering face value. One would assume that a big portion of these external investments either exited already, or may exit the market soon from fears of further currency devaluation.
The Brazilian government and the Central Bank are at an impasse: If they let the BRL devaluate quickly they risk higher inflation and faster money outflow from the market, which would force them to raise interest rates to much higher levels than of today’s, as they did in 1998. But if they do not devaluate, on the other hand, they will keep Brazilian exports prices uncompetitive, as they are now, and keep the level of imports inflow at unsustainable levels. Either scenario will not be good for the economy in the medium term, but the central planners will have to make the necessary adjustments at some point.
Contrary to many economists’ forecast, I believe the BRL may not converge back to 1,75 and continue its devaluation trajectory to around BR$2,30 in 2012, hence putting interest rates at much higher levels. The current Selic rate is much lower than what it should be considering inflation at around 7% and the existence of a housing bubble in many cities in Brazil. Services inflation is also on the rise, and many factors may sustain its upward trend, such as new contracts for property rentals (which jumped by about 20% this month).
What does all this mean? It means that current GDP projections for 2012 might prove to be wrong considering Brazil’s economic sensitivity to the external scenario. One must also hope that China does not slow down significantly, or that Europe’s problems do not deteriorate. Brazil might be a good investment for the long term, but only when all these short-term issues go away. For now, one better stay on the fence and stop tooting the “Emerging Market” horn.
This article was written by Tom Elias exclusively to BrazilianBubble.com.
Mr. Elias is an investment professional and business consultant with 30-years of high-tech and manufacturing experience in Brazil and the U.S.
To contact him, please write an email to firstname.lastname@example.org