BEST IDEAS UPDATE: PARTY TIME IN BRAZIL?

Takeaway: Our bullish bias on the BRL is working and, as anticipated, so are Brazilian equities & EM assets broadly. We see further upside from here.

EM RELIEF RALLY “ON”

On Wednesday, we published our updated thoughts on EM capital and currency markets strategy (CLICK HERE to review). That piece was long and thorough, so in the interest of not taking up too much of your time on a Friday afternoon, we’ll keep this note brief...

The key takeaway is simple:

We are broadly bullish on EM assets with respect to the intermediate-term TREND duration. On a forward-looking basis, we no longer see the same globally interconnected headwinds that caused us to get so pervasively negative on emerging markets roughly 1Y ago when we introduced the first of many subsequent presentations supporting our #EmergingOutflows theme.

Indeed, it would seem that the relief rally we started to call for on our FEB 27 conference call on Brazil has materialized and we anticipate further upside. Moreover, the nature of the rally (i.e. being led by the countries generally perceived as the most risky) is very much in line with our expectations.

  • EM assets are up +1.9% on average at the asset class level since then… that compares to a -0.3% decline for the US equity market over that same duration.
  • EM country-level ETFs are up +1.6% on average… India (EPI) at +11.9%, Turkey (TUR) at +10.6%, Indonesia (EIDO) at +7.6% and Brazil (EWZ) at +7.2% account for the four positive divergences (i.e. > +1 sigma vs. the mean) in the sample.

PARTY TIME IN BRAZIL?

Looking into Brazil specifically, yesterday we received the first of what is likely to be several supportive catalysts with respect to our bullish bias. Specifically, a CNI-Ibope poll showed President Rousseff’s approval rating  ticked down to a record-low of 51%; that marks the first sequential decline since JUL ’13, when millions of Brazilians took to the streets across the country in protest over inflation and the mismanagement of public funds.

The results of the poll are supportive of our belief that: A) the threat to Dilma Rousseff’s presidency is real come OCT 5th; and B) at the bare minimum, popular discontent will amplify the perceived failures of her economic policies during the campaign season, which opens the door for her Worker’s Party (PT) to cede share in the Brazilian legislature. One-third of Senate seats are up for grabs in the upcoming general election and as are all 513 seats in the Chamber of Deputies. To the extent opposition parties form a stronger mandate we could see a gridlock-induced cap on Rousseff and Finance Minister Guido Mantega’s expansionary fiscal policies – assuming they even return to power in 2015.

In conjunction with the news release yesterday, the BRL jumped nearly a full +2% vs. the USD; Brazil’s benchmark Bovespa Index ripped +3.5% and was led by state-run companies like Electrobras (+9.8%) and Petrobras (+8.1%). We continue to think contrarian equity investors will find PBR as attractive on the long side as we do amid the prospect for fuel pricing reform and a likely acceleration in production growth. Refer to our FEB 27 slide deck for more details.

Lastly, we just wanted to thank Standard & Poor’s for Monday’s downgrade of Brazilian sovereign debt for helping cement what we clearly think is: A) a bottoming process in the prices of Brazilian financial assets; and B) a topping process in pervasively bearish sentiment towards Brazil among international capital allocators.

IT’S NOT JUST A BRAZIL THING

If you are looking for some long ideas in the EM space, then you’ve come to the right place. We have a number of high-conviction ideas that: A) have been working; and B) we expect will continue working as additional catalysts materialize.

  • Long India: The EPI ETF is up +12.4% since we outlined our thesis on OCT 29; that’s good for the third best performance across the basket of EM country-level ETFs we track.
  • Long “New China” (CQQQ + CHIQ)/Short “Old China” (CHIX + CHXX): On an equal-weighted basis, this strategy is up +18.4% since we outlined our thesis on DEC 4.
  • Long Indonesia: The EIDO ETF is up +19% since we outlined our thesis on JAN 30; that is the best-performing EM country-level ETF over that duration.

BEST IDEAS UPDATE: PARTY TIME IN BRAZIL? - EM Divergence Monitor

BEST IDEAS UPDATE: PARTY TIME IN BRAZIL? - 2

We need to do more work on the long side of Turkey (TUR), lol… the mean reversion opportunity afforded by a -33.9% YoY decline is substantial indeed!

In all seriousness, please shoot us an email if you want to see our work on any of these plays and we’ll be happy to get the relevant materials over to you and/or to set up a call.

Have a great weekend,

DD

Darius Dale

Associate: Macro Team