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Brazil outperforms China--but still a bit early to buy, I think
01/11/2012 1:03 pm EST
A January 6 survey by the Banco Central do Brasil published on January 9 showed economists cutting their forecast for inflation in Brazil for the sixth consecutive week. Economists now forecast that inflation will climb by 5.31% in 2012.
That’s only a tiny drop from the 5.32% forecast of the week before but it keeps the trend pointing downward. It comes on the heels of a surprisingly low inflation reading in December that pushed inflation for 2011 just below the top of the bank’s target range of 4.5% plus or minus two percentage points. It was the first time in 9 months that inflation came in below the top of the bank’s target range and it let the central bank squeak through the end of 2011 without having to impose any new restrictions on an economy that has seen growth slow to 2.9% in 2011 from 7.5% in 2010.
This all leaves the central bank free to continue the policy of interest rate cuts that it began in August. At that time inflation was running above the central bank’s target. The bank took considerable criticism for cutting rates based on a projection that inflation would end 2011 below the top of its target range.
With the most recent news on inflation economists now expect the central bank to cut interest rates another 0.5 percentage points to 10.5% at their January 17 to 18 meeting, and to 9.5% by the end of the year. That should be enough, economists now project, to send Brazil’s growth rate for 2012 back up to 3.3%.
Not a huge improvement from 2011 but even that slight acceleration to 3.3% would indicate that Brazil’s growth rate has bottomed and that we were looking at the upward part of the cycle.
All this should sound familiar to readers of my recent posts on when to invest in China. What I’m looking for in that market is evidence that China’s slowdown has bottomed—so that the trend is upward from there. One precondition for that bottom, I’ve said, is an actual interest rate cut from the People’s Bank of China. That might come as early as June, I estimate.
In Brazil we’ve already got the interest rate cuts—beginning in August 2011—we’ve got evidence in actual numbers that inflation is falling enough to keep the interest rate reductions coming—and it looks like Brazil’s GDP might begin to accelerate, modestly, from the 2.9% growth of 2011 maybe as early as the first quarter or 2011.
Does that mean you should put money into Brazil now? Or should you wait until the turn in China is clear?
China is the big gorilla of all emerging markets and developing economies. Other emerging financial markets rise or fall with China’s economy because, in general, China’s demand for raw materials drives economic growth in countries such as Chile (copper) or Indonesia (coal) or South Africa (coal, platinum and palladium.)
That dependency exists for Brazil—to a degree—because the country is a big exporter of raw materials such as iron. But the balance in Brazil’s economy between exports and domestic consumption resembles the balance in the U.S. economy much more than it does the balance in the typical emerging economy. In the United States domestic consumption—the good old U.S. consumer—makes up about 70% of GDP. In Brazil domestic consumption accounted for 63% of GDP in 2010, according to the International Monetary Fund. In China the consumer share of GDP has been falling for a decade and is now just 35%. (Which tells you something about how hard “re-balancing” China’s economy is going to be.)
In reality then, Brazil’s economy and many of its domestic companies are far less sensitive to China’s growth rate than the market gives them credit for.
Does “reality” matter, though? If worries about a hard landing in China are relatively restrained, I think the shares of Brazil’s domestic companies can go up on improving Brazilian macro trends even if China lags. And if the two markets rally, I think Brazil would out perform. That’s what we’re seeing now with the iShares MSCI Brazil Index (EWZ) up 4.1% for 2012 through January 9 and the Shanghai Composite Index up just 1.2% for 2012.
But if worries about a hard landing in China turn into real fear, I think it will be tough for Brazil to show a positive return whatever the “reality” of Brazil’s economy. When fear gets high, investors tend not to have much time for distinctions about the composition of individual country’s GDP.
The safest course now would be to hold off on investing in Brazil until the trend in growth shows a bottom in China. That might well mean you leave something on the table in Brazil, but you also reduce the risk that you’re Brazilian positions will get hit by a shift to the risk-off trade that has punished emerging market stocks repeatedly in 2011.
If you were willing to take the risk, or think I’m being inordinately cautious, my suggestion would be to stick with domestically oriented Brazilian stocks, especially if they pay a dividend. I’d put AmBev (ABV), Gol (GOL), Itau Unibanco (ITUB), and CPFL Energia (CPL) in that group. (Steelmaker Gerdau (GGB), a member of my Jubak’s Picks portfolio http://jubakam.com/portfolios/ doesn’t fit into this category because it gets roughly half its sales from North America.)
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares in Gerdau, Gol and Itau Unibanco as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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