To download the presentation materials, please click here: HEDGEYE BLACK BOOK: The Roadmap for Investing in Brazil
Where We’ve Been:
We’ve been aggressively bearish on Brazilian equities for the last nine months. Down just under -26% YTD and nearly -30% from its early November peak (coincidentally right when QE2 was formally introduced), the Bovespa Index’s dramatic underperformance is appropriately reflecting the three key concerns facing the Brazilian economy we outlined many months ago:
- Growth is Slowing;
- Inflation is Accelerating; and
- Interconnected Risk is Compounding.
To the first point on Brazil’s domestic growth curve, real GDP growth has slowed from +6.7% YoY (3Q10) to +4.2% YoY (1Q11) with further downside to the reported 2Q and 2H figures according to our models. From a higher-frequency perspective, the strong real (widening interest rate differentials) and higher cost of credit have weighted substantially on Brazil’s manufacturing sector, with industrial production growth coming in a mere +0.9% YoY in June, alongside a contraction in PMI to 47.8 in July.
To the second point on Brazil’s domestic inflation readings (perhaps the core component of our Brazilian Stagflation thesis), CPI accelerated in July to a 73-month high of +6.9% YoY and our models see one more month of sequential acceleration from a YoY perspective (as does the central bank’s).
To the latter point on interconnected risk, we’ve been appropriately bearish from a research perspective on the big things in Global Macro. Be it calling for global Stagflation in January, reaffirming our long-term Housing Headwinds call in 1Q, or staying ahead of key developments within the Sovereign Debt Dichotomy, we certainly won’t be accused of being broadly bullish in 2011. Though none of this has anything to do with Brazil on paper, the nature of our interconnected Global Macro model has kept us out of the way on the long side of many assets YTD – including Brazilian equities. Managing risk on any country or security doesn’t occur in a vacuum.
Where We’re Headed:
In this presentation (see link above), we detail the key issues facing the Brazilian economy from a long-term perspective. Additionally, we walk through what we’d need to see from a variety of perspectives to turn constructive on Brazilian equities. This report isn’t an “act now” piece. Rather, it’s our best shot at producing a desk reference for managing the currently foreseeable Macro risk in and around Brazil over the long-term TAIL.
At current valuations, Brazil is no doubt atop a lot of investors’ minds as it relates to timing the “turn”. Understanding that bottoms are processes, not points, the issues and catalysts outlined in this report should help to adequately frame the bull/bear debate – a debate that, up until the last couple of weeks, we felt the market wasn’t having properly.
If there’s one thing we learned from attending the recent Bloomberg Brazil Summit, it’s that the delta between consensus long-term expectations for the Brazilian economy and our own conclusions are as wide, if not wider, than any country in my universe (Asia; Latin America). We think the road ahead for Brazil is rockier than consensus thinks it is and the headwinds themselves are vastly misunderstood by many. Given, we’ve taken the liberty to highlight the key issues going forward, in addition to identifying the potential solutions one must watch for as an indicator(s) that it’s time to buy.
Happy bargain hunting out there; just be sure to ignore Brazil for now. The Bovespa’s current quantitative setup (Bearish Formation) is telling us that some of the key intermediate and long-term issues we’ve outlined in this 75-page report aren’t fully priced in. When they are (at least on the margin) we’ll be among the first to signal.