I still remember my first visit to Rio de Janeiro, the most sensual, impossibly beautiful city I had ever seen, a whirlwind of vivid memories even now. Yet, I was horrified by Brazil’s economic predicament in the early 1990s. Hyperinflation. Sovereign debt crises. Banking failures. A President (Fernando Collor) impeached for corruption and narcotics. So many serial debt crises that the Finance Minister would just change the name of the currency when things went bad – cruzeiro, cruzado, novo cruzeiro, cruzeiro real. Then Brazil President Cardoso hired my old Wharton prof Arminio Fraga, then a director at Soros’s Quantum Fund. Dr. Fraga became the Governor of the Brazilian central bank and achieved macroeconomic stability with his Real Plan. Brazil is my favourite emerging market in 2020. Why?
One, Brazil has elected a pro-business, pro-reform, pro-US President Jair Bolsonaro in contrast to the socialist demagogue Andres Manuel Lopez Obrador in Mexico or the discredited, populist Peronists in Argentina. Bolsanaro has demonstrated his commitment to reform by locking horns with the Congress in Sao Paulo over pension reforms. His Economy Minister Paulo Guedes, a founder of BTG Pactual, is Wall Street’s most respected technocrat in Latin America, primus inter pares in an economic policy dream team. This fact alone makes Brazil the darling overweight of Latin American fund managers in 2020.
Two, while third quarter GDP growth was a modest 0.6%, it beat Wall Street’s expectations. The conclusion is unmistakable. Latin America’s largest economy is on the precipice of a cyclical recovery, goosed by Senhor Guedes’s supply side reforms, deregulations and privatization initiatives. China’s steep GDP growth decline to the lowest in a generation, the Wuhan coronavirus and President Trump’s recent tariffs on steel imports to the US are obviously headwinds for the Brazilian soyabean/iron ore exports but the recent OPEC Russia pact to increase output cuts to 1.7 MBD keeps a floor under Brent crude prices – crude oil and LNG are Brazil’s third largest export earner.
The Brazilian economy is still haunted by the savage scale of its worst recession since the 1930’s Great Depression and the fallout of the Lavo Jato scandal that saw the political disgrace of ex-Presidents Lula da Silva and Dilma Roussef. Yet Brazil is now recovering from a lost decade in economics. Property prices have begun to rise in Rio and Sao Paulo. Agribusiness exports have surged. Capex and consumer spending, consumer confidence and retail sales have begun to rise even in the depressed northern Amazon Basin provinces. George Soros said the big money is made when things go from “Godawful to just plain awful”, a historically accurate take on Brazilian equities. Economists forecast 2.6% GDP growth in 2020 and a dramatic fall in the 11.6% unemployment rate, both bullish omens for the Bovespa Index.
Three, Brazil’s real is one of the cheapest emerging markets currencies I track, down 17% against the the US dollar in the past 2 years. In fact, President Trump’s steel/aluminium tariffs were motivated by his anger over the Brazilian real’s “manipulated devaluation”.
Four, Brazil has achieved macroeconomic stability after the hyperinflation nightmares of the 1990s, when the policy Selic rate was 45%. Even a decade ago, I remember the Selic rate was 14-15%, yet after a dramatic fall in inflation (Brazil’s CPI is 4%), the interest rate is 5%. I see no reason why the central bank in Brasilia will not cut the Selic rate to as low as 4% to boost economic growth in 2020. This is largely bullish for Brazil’s embryonic corporate bond market and the Bovespa Index.
Five, Brazil’s economic Achilles heel was its fiscal black hole, some of the highest real interest rates on the planet and a vicious inflation risk/sovereign debt downgrade risk cycle. The historic pension reform bill enacted in October 2019 and Paulo Guedes’s reforms of the anachronistic, byzantine tax code are both game changers for Bovespa bulls like Senhor Matteo – moi.
Six, Brazil’s privatization program will be a $100 billion bonanza for global investors. Privatizations have raised $20 billion and Brazil will sell stakes Petrobras, Electrobras and the Brazil Development Bank, in 2019 Privatizations, pension fund reforms and the Finance Ministry’s curbs on state/local government spending are all bullish metrics for Wall Street.
I cannot not gloss over the difficulties in enacting the legislation necessary to make this happen, given that there are deputies from 30 political parties in Brazil’s Congress yet Paulo Guedes forged a coalition to enact both pension fund reform and privatization. This is Brazil’s do or die moment, akin to the impact of the Raegan revolution on the US economy in the 1980s or India’s Dr. Manmohan P. Chidambaran (Harvard and Tihar Jail alumnus) reforms in India circa 1991.
Seven, Brazil’s financial assets have still not repriced the dramatic fall in inflation and interest rates since mid-2016. Finally, Brazil’s mega cap companies like Petrobras and Electrobras can retire expensive Eurobond debt and borrow in the local real bond market at cheap rates. The retail brokerage XP Investments IPO in New York at a $14 billion valuation was a blowout., given that AUM had increased by a stellar 50% – a testament to the revolution in Brazil’s credit markets. I compare Brazil in 2020 to the US in the early 1980’s, when Paul Volcher choked inflation with 18% Fed Funds rates. The Dow Jones bull market began in 1982 at 750 points. The Dow Jones is near 29,000 as I write. So remember Mark Twain’s words. History does not repeat but it surely rhymes.
Eight, Brazil’s real has lost 20% due to King Dollar, the commodities slump, the emerging markets malaise and the dramatic fall in Brazilian sovereign bond yields. The Bovespa has risen 18% since Bolsanaro won the Presidential election in late 2018 but it nowhere reflects what could – in my brain, what will – happen in the next three years. I believe Brazil will morph into a secular bull market, an emerging market fairy tale whose twin Prince Charmings are Bolsonaro and Guedes.
President Charles de Gaulle once sniffed that Brazil was a “country of tomorrow and always will be.” Wrong. Brazil, after decades of military rule and economic trauma, has finally reached its tomorrow. Or so I hope.
Brazil’s economics, capital markets and sovereign debt risk faces revolutionary ferment due to disinflation and Bolsanaro’s reforms. This means Brazil bank shares are no brainer EM crown jewels for me. Take Itaú Unibanco, the largest index weight on the Bovespa and Brazil’s largest banking empire.
Banco Itaú Unibanco is Brazil’s largest private commercial banking conglomerate. It is taking market shares from Brazil’s bad debt crippled state development banks and loan growth will accelerate in 2020. ITUB has the most under-leveraged balance sheet in Latin America with stellar access to global funding markets/liquidity, strong Basel Tier One capital ratios and has earned 18-20% RDE since the Cardoso/Fraga era in the late 1990s. I prefer Itaú Unibanco for its scale/operating metrics/low leverage to say, Banco Poradeso in Brazilian finance.
Petrobras is Brazil’s Aramco, though with its New York ADR, I have traded since the 1990s. The Jato Lavo scandal tainted its CEO and his cronies are out and the new boardroom caudillos are committed to productions growth, asset sales and the use of its free cash flows to slash epic debt levels. Brazil’s cyclical recovery and the Saudi-Russian pact to nudge Brent higher is also positive for Petrobras’s New York ADRs. Five Bagger internet/e-commerce unicorns in Brazil? The Samba Guru, my buddy since 1998, sits in his Dubai textile market aerie and plots the Memon takeover of Rio!