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Takeaway: We no longer consider Brazilian equities or the BRL good investment opportunities on the long side with respect to the TREND duration.

SUMMARY CONCLUSIONS:

  • Not much else needs to be said other than the fact that it has recently become clear to us that Brazilian policymakers refuse to address the country’s growth/inflation imbalance – which they themselves  have perpetuated through currency debasement – with an adequate amount of exchange rate appreciation (we already know Dilma won’t budge on rates).
  • As such, we no longer consider Brazilian equities or the BRL good investment opportunities on the long side with respect to the TREND duration and are now looking to explore other asset classes within the region. Email us if you’d like to get a dialogue started on such.
  • At first glance, Mexican equities, the MXN, Peruvian equities and the PEN all look like more favorable replacements, but we need to more work on each prior to endorsing a fundamental long bias(es).

KEY IDIOSYNCRATIC DEVELOPMENTS:

  • Losing the “war” at home: Brazil is flat-out losing what Finance Minister Guido Mantega dubbed in SEP 2010 as the “Currency War” – mostly because of Brazilian policymakers’ own doing. The ~2yrs of capital controls (which are now slowly being reversed) did little to boost economic growth; 2012 real GDP should come in at roughly +1% YoY – the slowest since 1999 outside of the -0.3% YoY decline in 2009.
  • Inflation is not growth: The weak BRL did, however, boost inflation, which has exceeded the median central bank’s 4.5% +/- 200bps target for 29 consecutive months! The aforementioned bastardization of international capital also contributed to a drop in investment, which shrank to ~20% of GDP last year (vs. ~48% for China), according to preliminary IMF estimates.
  • Small measures won’t cut it: Now, in order to combat the now-obvious ramp in CPI that has stemmed from burning the BRL over the past ~2yrs, the Brazilian government has just resorted to scrapping all taxes on the basket of staple foods (after Rousseff herself vetoed a similar measure back in SEP). This latest counter-inflation measure out of the Brazilian government is in addition to their recent use of forceful negotiation tactics with Brazilian utilities in order to drive down energy tariffs for Brazilian consumers and businesses.
  • Too little; too late: We were giving Brazil and its meddling policymakers the generous benefit of the doubt on the long side of certain pockets of the equity market and the real, but Monday’s TREND-line breakdown on the Bovespa Index was our signal to get off the horse here and we no longer like Brazil or its currency after telegraphing this potential shift last week.
  • Mantega doesn’t get it: The breakdown was confirmed by Mantega’s latest statement on the BRL: “The government is ready to block exaggerated gains in the currency… the exchange rate isn’t an instrument to control prices and a weaker currency helps to protect the domestic industry from foreign competition.”
  • Pigheadedness ≠ policy: With a hint of arrogance, these comments show Brazilian policymakers haven’t learned anything from the past ~18-24 months of “exaggerated” policy failures. As such, Brazil is no longer on our Asia/LatAm Best Ideas list after having been there from 12/5 to 2/5 (upon confirmation of the 2/4 TREND line breakdown). Please see our 1/31 note titled, “WILL BRAZIL HOLD THE LINE?” for additional details on why we’re not looking to overstay our welcome here.
  • Great trade while it lasted, though:Over that duration, the following price deltas were recorded in the sectors and asset classes we liked:
    • MSCI Brazil Consumer Discretionary Index: +6.6% vs. a +9.2% gain for the MSCI Brazil Index
    • MSCI Brazil Consumer Staples Index: +13.9% vs. a +9.2% gain for the MSCI Brazil Index
    • MSCI Brazil Industrials Index: +14.8 vs. a +9.2% gain for the MSCI Brazil Index
    • BRL/USD: +5.2% vs. a +2.6% gain for the Bloomberg/JPM Latin America Currency Index
  • Unfortunately not a robust short opportunity:We wouldn’t necessarily short Brazil here because its forward-looking growth dynamics look to continue improving over the intermediate term. This signal is being confirmed by the first batch of JAN growth data:
    • Manufacturing PMI: 53.2 from 51.1
    • Services PMI: 54.5 from 53.5
    • Services PMI: 54.5 from 53.5
    • Exports: -1.1% YoY from -10.7%
  • Underweight Brazil: There are likely better ways to play the long side of Latin American equities and currencies over the intermediate term – a view that implies being underweight or zeroweight Brazil is the most appropriate strategy for the time being. 
  • Any replacements?: Looking to other opportunities within the region, we continue to like Mexican equities and the MXN and Peruvian equities and the PEN with respect to the intermediate-term TREND, though neither is currently a Best Idea. We’re currently doing more work on both. A bearish TAIL-duration bias on the Argentine peso (ARS) is our sole Best Idea remaining within the region now. We’ve held that view since NOV 4, 2010 and it is down -20.6% vs. the USD since then (vs. a much smaller -8.2% decline for the Bloomberg/JPM Latin America Currency Index). Email us if you’d like to dig in deeper there or if you would like to recommend that we take a look at other opportunities within the region.

GET OUT OF BRAZIL IF YOU HAVEN’T ALREADY - 1

 

GET OUT OF BRAZIL IF YOU HAVEN’T ALREADY - 2

 

Darius Dale

Senior Analyst