Time to Buy Brazil?

Conclusion: With the recent spike in crude oil prices, one might think Brazil is a good derivative play on the geopolitical risk in Northern Africa. Unfortunately, the math suggests otherwise and we are inclined to maintain our cautious stance on Brazilian equities.


Position: Bearish on Brazilian equities; Bullish on the Brazilian Real.


This is known: Brazil is an economy with vast natural recourses and uses those resources to profit from global demand for crude oil, sugar, corn, wheat, iron ore, and other commodities. 


This is, at times, is overlooked: Brazil is home to one of the world’s most unequal economies from an income distribution perspective. Brazil’s GINI Coefficient, which measures income distribution, is 57 – good for 11th highest in the world. That means Brazil is the 11th most unequal country in the world from a wealth dispersion standpoint – significantly more so than Egypt (34.4), Tunisia (39.8) and the United States (40.8).


We’ve been calling this out since November, but it’s worth repeating: You don’t want to be long countries where growth is slowing and inflation is accelerating – especially in poorer countries, where the citizenry is most apt to be plugged by rising food and material prices. While we didn’t necessarily predict events such as the Jasmine Revolution and Egypt’s current uprising, the tea leaves were most definitely telling us to stay out of Emerging Markets for the last 2-3 months.


Today, Brazilian equities continue to lose bids, despite the strength we’re seeing in crude oil prices (up over 3%) and commodity prices (up over 1.5%) on the day.


We are all well aware that Brazil is home to arguably the most robust consumer story in all of global macro. With record low unemployment (5.3% in Dec) and near-record low consumer loan rates (6.79%), it’s no surprise investors (including us) poured money into this story in 2010 – sending the Brazilian Consumer etf (BRAQ) up +30.3% in 2010 from its first trading day (7/8/10).


Both the price action and investor interpretation of the fundaments have reversed sharply in 2011, sending the BRAQ down over (-12%) YTD. The fundamentals themselves have been eroding for the last four to six months – particularly on the inflation front: 

  • The benchmark IPCA CPI reading accelerated in Dec to +5.91% YoY – a 25-month high;
  • Food Inflation, as captured by the same official IPCA index accelerated in Dec to +10.39% YoY – a two-year high; and
  • January is off to a “hot” start as well, with the unofficial FGV IGP-M CPI accelerating to +11.5% YoY – a 26-month high. 

Time to Buy Brazil? - 1


Ignoring the delta between the government’s reported numbers and the unofficial series (see: Egypt, Argentina, US, etc.), we see that inflation is indeed becoming the problem we anticipated a few months back. This issue is reflected in the Bovespa’s underperformance – falling (-7%) since it peaked on the 12th of January. With the exception of the now infamous EGX 30 (Egypt), that decline is tops among global equity markets over that duration. The fall leaves Brazil decidedly bearish from an intermediate-term TREND perspective.


Time to Buy Brazil? - 2


With the dollar catching no bid amid the acceleration of global geopolitical risk, we don’t see inflation as something that will quietly go away in Brazil. Brazil’s bond market agrees; yields on 10Y government securities having backed up +79bps since January 3rd. For what it’s worth, Brazilian economists see the same thing: the latest survey for full year 2011 CPI estimates came in at +4.7 YoY, up +16bps wk/wk.


Time to Buy Brazil? - 3


Unfortunately, for the poorest of Brazil’s citizenry, Brazilian policy makers have been reluctant to let the real appreciate meaningfully. Of the firm belief that the current bout with inflation is driven by rising commodity prices (see: India) the central bank is reluctant to use further rate hikes to beef up the real in an effort to combat rising inflation. Instead, Brazil continues to manufacture attempts to weaken the real, raising the reserve requirement on short dollar positions, authorizing the sovereign wealth fund to buy dollars and auctioning reverse swaps – all since January 1st.


Until Brazil’s central bank stops buying the IMF-led hype of “destabilizing fund flows” and “global capital imbalances” and realizes that inflation is priced locally and is a direct function of local monetary policy, the inflation issue will hang like a dark cloud over Brazil’s economy.


Perhaps the market is discounting this, understanding full well that Rousseff is a woman of the people and a strong advocate for Brazil’s poor. She’ll likely not let inflation get further out of control than it already is. Given this, we expect measured tightening on the horizon in the Brazilian economy, and a potential subsiding in anti real-strength policies. Perhaps the prospect of future real strength is the underlying reason Brazil’s Industrial Confidence fell in January (-1.5%) MoM. While merely a hunch at this point, we’d be remiss to ignore the interconnectedness of these risks.


If you’re still bullish on Brazilian equities, we’d recommend you buy them at an even greater discount at some point in the intermediate future. If you’re bearish, continue to watch the US dollar and how it interplays with commodity inflation. For now, the dollar is decidedly bearish-TREND, which, in turn, is bullish for global commodity prices on the margin. We don’t think we’ll see the usual benefit of these rising prices reflected in Brazilian equities until inflation subsides in Brazil – which is likely only to happen after a measured increase in hawkish monetary policy.


Darius Dale



Time to Buy Brazil? - 4

The Bounce: SP500 Levels, Refreshed

POSITION: no position in SPY


Fortunately I stayed with the risk management process and covered my short position in the SPY on Friday.


I am not surprised that we have seen the SP500 bounce from its immediate-term TRADE line of support at 1276. On Friday we obviously all knew that today would be ripe for month-end markups. After one of the most expedited 22 month rallies in US stock market history, I don’t expect the bulls to give up readily. Intermediate-term tops are processes, not points.


Friday’s move to cover doesn’t imply that I’m not bearish on US Equities anymore. It simply implies that I am waiting for a higher price to re-short them, selectively (we already re-shorted TGT this morning on strength). Friday’s moves in both volatility (VIX) and the SP500 were critical in that they arrested this almost surreal level of recent upward price momentum in US stocks.


Looking forward, here are a few important lines that I’m watching: 

  1. SP500 TRADE line resistance is now 1288
  2. VIX TREND line support is now 18.71 

If the VIX breaks down through that TREND line, I have no doubt the bulls will try to push the SP500 back toward its closing cycle-high of 1299. That said, 1299 is simply another lower-long-term closing high (think Nikkei 225 for 15 years) and when I think about this market’s long term TAIL, that’s bearish.


If the SP500 were to breakdown and close below 1276, that would be bearish too (TREND line support = 1224). In our S&P Sector model, we’ve already registered 5 of 9 Sectors breaking their immediate-term TRADE lines, respectively (XLY, XLP, XLV, XLB, and XLF). This is a bearish leading indicator.


If you covered some of your shorts on Friday, congrats. Don’t get sucked in on the long side today – this is going to be a volatile week.



Keith R. McCullough
Chief Executive Officer


The Bounce: SP500 Levels, Refreshed - 1

Shell, Transocean Shut Egyptian Offices, Evacuate


January revenues up 34% YoY



It looks like January table revenues will come in at HK$17.4 billion.  After adding in an estimate for slots, total gaming revenues will fall short of our HK$18.5-19.0 billion estimate at HK$18.2, up 34% YoY.  Business slowed in the last week more than we thought in the lead up to Chinese New Year.  In terms of market share, Wynn continues to suffer from low hold and we are hearing LVS held pretty well the past week.  MPEL’s share actually grew from an already healthy clip and looks like the most interesting stock in the group.  Here are the numbers:



R3: Boots, Rentailing, SHOO, & Taxes


January 31, 2010




  • American Express is taking the commercialization of NY’s Fashion Week to new heights this year.  As a cardholder, you are now entitled to buy a ticket to your favorite designer show for as little as $50.  Paying a little more gets you a meet and greet as well.  With costs on the rise, perhaps the organizers are looking to generate a little income as an offset?
  • Two major bridal launches will take place over the next couple of weeks.  First up is the collaboration between David’s Bridal and Vera Wang called White.  The items in the collection are expected to price between $600 and $1400.  Up second, is the long-awaited URBN bridal concept called BLDHN which launches in online-only form on February 14th.  The brand’s first prototype store is expected later in the year.
  • With much of 2010 focused on private/flash sale websites and early 2011 hyper focused on all things Groupon, it’s worth pointing the recent winner of the Fashion Group International rising star in retail award.   This year’s winner is Rent The Runway, a site that allows women to rent couture for single usage.  With costs escalating and fashion changing at an exhaustive rate, perhaps this will be the next trend in “Rentailing”.




American Apparel Could Breach Debt Covenant -  It’s crunch time once again for Dov Charney, chief executive officer of American Apparel Inc., who has made a habit out of living on the edge, financially and otherwise. The company, which has most recently courted controversy by featuring explicit drawings of topless women in its advertising, faces a key financial test today — a minimum consolidated earnings before interest, taxes, depreciation and amortization covenant in its loan agreement with Lion Capital, which will be tested monthly this year. <WWD>

Hedgeye Retail’s Take:   While the media loves to focus its attention on Dov Charney’s extravagant image, the rapid expansion across the globe in almost every major high rent district is the culprit here.  And, with cotton at all time highs it’s hard to envision the monthly “tests” being passed with consistency.


Retailers at Cobb Show Still Struggling - Huge discounts from the major retailers bit into holiday business for most specialty stores shopping the Cobb Show here last week, and they haven’t recovered yet. “The urban market didn’t do well because the big stores were dumping their goods,” complained Neil Rama, co-owner and buyer of Brite Creations in Atlanta. “The smaller stores can’t do that.”“The holiday season was our worst in 40 years,” said Khair Askar, owner of New York Men’s Clothing in Boynton Beach, Fla. “We were giving away merchandise — selling at very low prices, and business still wasn’t good.” <WWD>

Hedgeye Retail’s Take:   While it’s no secret that holiday was promotional, it certainly appears that this has taken a disproportionate toll on the little guy.  Not only was there pricing pressure, but inventories now remain tight in the supply chain as cost pressures mount.


 Boot Sales Rise on Record Snowfall - Record snowfalls blanketing the Northeast have been a boon for the footwear business. Retailers across the region told Footwear News boots, in particular, are marching them out of an otherwise slow season. “Snow is like heaven — it’s actually the best thing that could happen at this time of the year because January and February are usually sale periods with real markdowns,” said Danny Wasserman, owner of Tip Top Shoes in New York. <WWD>

Hedgeye Retail’s Take:  Perfect timing for record snow as clearance activity has been kept to a minimum in the boot category.  Even more impressive is that this marks the third year in a row of a strong boot season, a trend that very rarely occurs.


Barney's new era - One of the most-watched acts in fashion is beginning to play out: Mark Lee's reinvention of Barneys New York. The highly regarded Lee has been Barneys New York's chief executive officer for only four months yet already has made sweeping changes in the retailer's senior fashion ranks and overhauled its creative leadership. On Friday, the retailer tapped a new vice president and fashion director, Amanda Brooks, former creative director of Tuleh and a Vogue contributor. And more changes are said to be on the horizon. <WWD>

Hedgeye Retail’s Take:  With an ever increasing focus on more contemporary designers over the past several years it will be interesting to see what changes truly make their way one of the world’s most iconic luxury retailers. 


Steve Madden Plots Betsey Johnson's Growth - Rather than wait out the still-stalled economy, Steve Madden is on the hunt for new labels and is ramping up Betsey Johnson’s business.  Last fall Steven Madden Ltd. took over a $48.8 million loan to Johnson’s firm and absolved it in exchange for ownership of the brand’s intellectual property. Madden is so comfortable with the designer’s stewardship that he will be at a Las Vegas shoe show instead of her Feb. 14 runway show at Lincoln Center. <WWD>

Hedgeye Retail’s Take:  With portfolio of growing brands beyond shoes, Madden is quickly becoming a meaningful player in the moderate priced fashion space. It’s likely we’ll see exclusive collaborations with major department stores as part of the strategy to drive stable volume in these growth brands and categories.


Demand in China for polyurethane materials on the surge - Demand on polyurethane materials for making footwear soles will be growing substantially if the EU's anti-dumping duty on Chinese leather shoes can be ended at the end of March this year, according to China Leather Industry Association. The shoe production and export will increase definitely if the duties are removed, said industry expert. Leather shoe production dropped significantly as EU anti-dumping and trade protection from Brazil, Argentina, Peru and Ecuador against Chinese shoes. <FashionNetAsia>

Hedgeye Retail’s Take:   Footwear inflation potentially on the horizon?  Or will production from China actually drive prices down?


E-retailers win tax ruling in Colorado - Colorado isn’t going to get the help it hoped for from online retailers in collecting sales taxes on web purchases made by state residents, at least not now. A federal judge in Denver has granted a preliminary injunction against parts of a Colorado law that require Internet and catalog retailers to provide the state with information including an annual report providing the amount of sales to individual Colorado residents. The ruling came in a lawsuit filed by the Direct Marketing Association, a trade group for direct-to-consumer retailers and marketing companies. <InternetRetailer>

 Hedgeye Retail’s Take:  While the battle to collect state sales tax from online retailers appears to have met some obstacles in Colorado, don’t expect the issue to go away anytime soon.  The technology is in place to make the collection process seamless and state budget gaps are not likely to disappear anytime soon.


Carrefour Rises on Report Retailer Mulling a Split - Carrefour SA advanced in Paris trading after a French newspaper reported that the world’s second-largest retailer may be split into three parts to boost the value of its shares.  The stock rose as much as 3.3 percent to 35.10 euros and traded at 34.70 euros as of 12:05 p.m. in Paris. The company, with the backing of shareholders including Bernard Arnault, may create separate stock-exchange listings for its Dia discount chain and real-estate units, Le Figaro reported, without saying where it got the information. Florence Baranes-Cohen, a spokeswoman for Carrefour, declined to comment. <Bloomberg>

Hedgeye Retail’s Take:  Bigger doesn’t appear to be better, at least for the moment.  Likely much more to come from this speculation in the coming days.

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