Editor's Note

10/25/2007 12:00 am EST


Howard Gold

Founder & President, GoldenEgg Investing

October 25, 2007

If the Chinese stock market is the Mother of All Manias, as we wrote here last week, she's got a close cousin who's not far behind.

But he lives half a world away and speaks Portuguese, not Mandarin. You know who I mean: Brazil.

Over the past decade-and especially during the last five years-Brazil has been a juggernaut. From a desperate debtor nation with a chronically weak currency, the country now has a substantial surplus, solid economic growth rate and a real that has appreciated more than 60% against the US dollar.

So, no more cheap vacations in Rio, folks.

In fact, by some measures, Brazil's Bovespa index has been the best performing major market in the world. Up around 40% this year, it has skyrocketed more than 1200% from its lows in September 1998, following the Russian ruble crisis-easily topping China and India's spectacular gains (see Chart).

What's behind this meteoric rise? Well, if China is the equivalent of a dot.com stock, Brazil is like a corporate turnaround. Economists and analysts have seen its vast potential for decades: it's the world's fifth largest country in land area and population (pushing 190 million), with awesome mineral wealth and a world-class financial center in Sao Paulo, whose metropolitan area is about the size of New York's.

But economic mismanagement and the various malaises connected with developing nations held it back.

"Brazil is the country of the future-and always will be," the old joke went.

Well, the future is now.

Presidents Fernando Henrique Cardoso and his successor, the incumbent Luiz Inacio Lula da Silva, have helped make Brazil a paragon of fiscal responsibility and stable growth. Under the putative "leftist" Lula, the country achieved a budget surplus and paid off its debts to the International Monetary Fund two years ahead of schedule. 

The stabilization came just in time for a global commodities boom, spurred largely by China and India's rise as world economic powers. 

Brazil was ready: it is overflowing with valuable minerals, such as iron ore, copper, bauxite, tin, and uranium. Iron ore especially has been a key export, going into the steel that is building new factories, skyscrapers, airports, and bridges now going up throughout China, India and other rapidly growing countries.

As a major food producer-agriculture is one third of gross domestic product-Brazil also supplies vast quantities of coffee, sugar, beef, and soybeans.

And Brazil's three-decade-long investment in production of sugar-cane-based ethanol has made it energy-independent  and even poised to become a major energy exporter.

The result: Brazil's GDP approaches $1.8 trillion (adjusted for purchasing power) and its foreign currency reserves top $160 billion. Economic growth averages around 4% and inflation has been tame.

Finally, big reforms have transformed the Bovespa itself from a corrupt little club into a major international exchange. The creation of the Novo Mercado in 2000 has created a class of companies that have pledged to abide by higher standards of corporate governance and transparency

No wonder international investors now comprise a third of the trading volume on the Bovespa.

It's clear Brazil has made a lot of the right moves-and investors have profited richly. So, what could go wrong?

How about the law of gravity? By some measures, the Bovespa is one of the most expensive markets in the world, with a P/E of over 60x estimated 2007 earnings  

Profits are expected to grow rapidly this year but only at about 12% annually in the next few, putting the Bovespa in nosebleed range.

And if you're looking for the proverbial bell they sound at the top of a market, listen to this: the Bovespa itself is going public in an initial public offering that values the exchange at about half that of the New York Stock Exchange, according to the Financial Times, even though trading volume on the Bovespa is less than 10% that of the NYSE.

Still, the offering was as much as ten times oversubscribed. Big investors "don't want to miss the boat," one analyst told The Wall Street Journal. Uh-oh.

Also, in important ways Brazil is joined at the hip to its booming cousin, China, and is quite vulnerable to an economic slowdown.

"If the US goes into a mild soft landing and China keeps growing, then Brazil will continue to grow," says Dr. Vitoria Saddi, senior economist for Latin America for New York-based RGE Monitor, which publishes a free blog on Latin America.

"If Europe and the US slow down, it's going to be a problem," she adds.

But the biggest problems Brazil faces may not be purely economic.

Corruption is rampant, and the gap between the rich and the poor is third worst in the world, behind only Ghana and Bangladesh, Dr. Saddi says.

The glittering metropolises of Sao Paulo and Rio de Janeiro are filled with some of the globe's most horrific slums, called favelas, which are dominated by powerful drug gangs and are as beyond the reach of the law as the tribal regions in Pakistan.

Kidnapping is so pervasive that it's a standard topic of cocktail-party conversation: Even middle-class professional families in Sao Paolo must send their children to school in bullet-proof cars, Dr. Saddi says.

The award-winning -journalist William Langewiesche, in an alarming article in the April 2007 issue of Vanity Fair, described how a fearsome, secretive drug gang, P.C.C., which runs out of Brazil's prisons, brought the nation's largest city to a chilling halt:

"On the afternoon of Friday, May 12, 2006, Sao Paulo came under a violent and coordinated attack. The attackers moved on foot, and by car and motorbike. They were not rioters, revolutionaries, or the graduates of terrorist camps. They were anonymous young men and women, dressed in ordinary clothes, unidentifiable in advance, and indistinguishable afterward.

"Wielding pistols, automatic rifles, and firebombs, they emerged from within the city, struck fast, and vanished on the spot.The attackers did not loot, rob, or steal. They burned buses, banks, and public buildings, and went hard after the forces of order-gunning down the police in their neighborhood posts, in their homes, and on the streets. The police shot back and killed some people, but the others did not stop. They were like ghosts.The government had no idea how to respond."

A word to the wise: In many ways this is very much an "emerging" market.

Related Video

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Fund Recommendation: Cash in on the Hottest Emerging Markets

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Howard R. Gold is editor-in-chief of MoneyShow.com. The opinions expressed here are his own and do not necessarily reflect the views of InterShow.

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