Conclusion: Our refreshed GROWTH/INFLATION/POLICY outlook points to more downside in both Australian equities and the Aussie dollar relative to Brazilian equities and the Brazilian real over the intermediate-term TREND. Further, we continue to like Brazilian equities on their own merits over the intermediate term – irrespective of this pairing – as a deflating of the inflation provides additional headroom for growth-supportive monetary and fiscal policy amid a baseline backdrop of accelerating real GDP growth.
Virtual Portfolio Positioning: Closed our long position in Brazilian equities (EWZ); and currently short Australian equities (EWA).
Late last week, Keith initiated a long position in Brazilian equities and opened a short position in Australian equities in our Virtual Portfolio (the former has since been booked for a +2.4% gain). While both benchmark indices are fairly levered to the inflation trade, we find that Brazil’s domestic fundamentals are more supportive of equity returns and multiple expansion than Australia’s at this current juncture.
Starting from our baseline GROWTH/INFLATION/POLICY model, Brazil’s 2Q12 outlook appears decidedly more positive than Australia’s from an equity investor’s perspective. We are comfortable adopting this baseline scenario in part due to it being confirmed by the latest high-frequency data via the slopes of both countries’ PMI, employment, and inflation statistics.
From a foreign exchange risk perspective (both etfs are un-hedged), we continue to see long-term mean reversion risk in the Aussie dollar vs. the U.S. Dollar. For more details regarding this thesis, refer the following notes listed at the conclusion of this note. From an intermediate-term perspective, the Aussie dollar also looks poised to make lower-highs vs. the USD given the AUD/USD currency pair’s preponderance to trade in tandem with commodities and U.S. equities – two asset classes we are explicitly bearish on (short the SPY; ZERO percent allocation to commodities in the HAA).
- Trailing 3yr correlation to the CRB Index: +93%; and
- Trailing 3yr correlation to the S&P 500: +94%.
Looking at the Brazilian real, there appears to be less downside risk from a mean reversion perspective. The real – which is down -5.8% over the last month vs. the USD amid a politicized commitment to lower the country’s aggregate interest rate burden – is down -8.4% over the LTM and up only +38.5% since its trough financial crisis exchange rate (12/8/08). This compares rather lightly to the Aussie dollar’s +74.9% gain from its trough financial crisis exchange rate (10/27/08).
While the various interest rate markets of both countries are signaling an outlook for continued monetary easing, Australia’s are pricing in decidedly less easing over the NTM – which intuitively makes sense given RBA Governor Glenn Stevens’ reputation as the developed world’s most hawkish central bank chief, as well as Brazilian Central Bank President Alexandre Tombini’s drive to achieve and sustain mid-to-high single digit interest rates in Brazil (with political pressure from President Dilma Rousseff and Finance Minister Guido Mantega).
Net-net-net, our refreshed GROWTH/INFLATION/POLICY outlook points to more downside in both Australian equities and the Aussie dollar relative to Brazilian equities and the Brazilian real over the intermediate-term TREND. Our quantitative risk management levels on both countries’ benchmark equity index are included in the charts below.
Bearish Thesis on the Aussie Dollar:
- 5/19/11 – AUSSIE DOLLAR: DANCING ‘TIL THE MUSIC STOPS
- 7/27/11 – WE WOULDN’T WANT TO BE GLENN STEVENS RIGHT ABOUT NOW
- 10/11/11 – SHORTING THE AUSSIE DOLLAR
- 11/21/11 – COVERING THE AUSSIE DOLLAR: WE’LL BE BACK
- 12/13/12 – SHORTING THE AUSSIE DOLLAR: TRADE UPDATE
Bullish Thesis on Brazilian Equities:
- 9/1/11 – EYE ON BRAZILIAN POLICY: “OH NO YOU DIDN’T”
- 12/2/11 – WEEKLY LATIN AMERICA RISK MONITOR: ALL EYES ON BRAZIL
- 1/23/12 – WEEKLY LATIN AMERICA RISK MONITOR: ALL EYES ON BRAZIL PART II + A KING DOLLAR UPDATE
- 2/23/12 – TRIANGULATING LATIN AMERICA: DOES THE RALLY IN BRAZILIAN EQUITIES HAVE LEGS?