How To Profit From Brazil’s Economic Rise

After posting a contraction of GDP in the first quarter, Brazil looks to rebound back to its prior status as one of the fastest growing economies in the …

After posting a contraction of GDP in the first quarter, Brazil looks to rebound back to its prior status as one of the fastest growing economies in the world. The $1.5 trillion dollar economy has seen “Chinese-like” growth in some areas of their economy while their benchmark stock index has increased by 50% this year. For more on how to profit from the rise of Brazil, see the following article from Money Morning.

Brazilians used to joke that their country was the country of the future – and always would be because a new crisis seemed to crop up every time the economy came close to fulfilling its potential.

But given the economy’s strong performance following the financial meltdown that crushed economies the world over, it looks like Brazil’s time is now.

Brazil’s gross domestic product (GDP) contracted 0.8% year-over-year in the first quarter and 0.8% from the fourth quarter. That beat analysts’ expectations but wasn’t enough to keep the country from sliding into its first recession since 2003. However, the economy is already showing signs of recovery and many economists believe Brazil is already on the rebound and poised for a strong second half.

Brazil’s GDP likely grew 2.2% in the second quarter compared with the previous quarter, according to a report by Bank of America Corp. (NYSE: BAC).

Nelson Barbosa, Brazil’s economic policies minister, optimistically told the Rio de Janeiro-based O Globo newspaper that Brazil’s economy will grow by 4-5% this year.

That kind of optimism in July helped Brazil’s benchmark Bovespa stock index book its best monthly gain since 1998.  The index jumped 2.3% to 55,997.81 – its highest level in 11 months. It’s up about 50% this year, outpacing even the red-hot MSCI Emerging Markets Index. The Dow Jones Industrial Average and S&P 500 Index are up just 5.8% and 11% respectively.

Analysts that were skeptical of Brazil’s economic growth in the heady years leading up to the financial crisis pointed to the country’s supposed reliance on high commodities prices and exports.

No doubt, the country benefited a great deal from the commodities boom that drove up prices for Brazilian exports like iron ore, steel, and soybeans. But in eviscerating commodities prices and ravaging the market for exports, the financial crisis demonstrated that Brazil is more than a one-trick pony.

Sublime political stewardship leading up to and during the crisis kept Brazil’s economy well intact when global economy seemed to be falling apart. Stringent financial regulation shielded Brazil from the worst of the financial crisis, while government tax cuts and a growing middle class buoyed the country’s economy as exports dried up.

Back to the Future: Brazil’s Troubled Past Preserves its Present

Indeed, the very financial crises that had Brazilians believing their country would never find its place among the world’s elite economies endowed the nation’s policymakers with a streak of caution as they entered the 21st century.

“We are used to dealing with challenging environments, for our institutions and our regulations,” Alexandre Tombini, director for regulation at Brazil’s central bank, told the Financial Times. “Everything we have done since the mid-1990s has tended to take a more cautious approach.”

For instance, banks in Brazil are required to keep capital reserves that equate to at least 11% of their total assets. That’s high by most international standards, but many banks maintain capital ratios of 16% or more.

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Banks are also required to keep 30% of all deposits at the central bank. That makes borrowing more expensive, but it also made it possible for Brazil’s central bank to dole out $51.4 billion (100 billion reals) overnight to ensure banks were adequately funded.

Brazil’s high interest rates are another reminder of the hyperinflation that overwhelmed the economy in the 1990s. But those rates also kept lenders from getting carried away, and now that the crisis has subsided, inflation has been crushed and rates are plunging.

Brazil’s official IPCA consumer price index advanced 0.24% in July after posting a 0.36% gain in June, according to the Brazilian Census Bureau (IBGE). The rolling 12-month rate sank to 4.5%, down from 4.8% in the 12 months through June.

Brazil’s central bank has lowered its primary interest rate, the Selic-base rate, six times this year, with the most recent a 0.5% cut after the bank’s July 21-22 meeting. The benchmark rate currently stands at a record low of 8.75%.

With inflation subdued, most analysts believe the rate will be kept at its historically low level until at least 2010.

“With inflation under control, I believe it will permit the Selic to be maintained at this low level until at least the middle of 2010.”Alex Agostini, chief economist at local ratings agency Austin, told The Wall Street Journal. “I don’t seen any inflationary pressures on the radar. The inflation scenario is so well behaved that it could give the central bank room to make another rate cut at the next meeting, even though the signals coming from the central bank have indicated there will be a pause.”

And while U.S. regulators are only now looking into the inconsistencies and manipulations wrought by irresponsible futures trading, Brazil has long held the reins tight on such activity. Short selling – selling shares you do not own – is allowed, but naked short selling – selling shares that you don’t have – is kept under wraps by fines for traders who can’t to deliver shares they have sold within three days.

Additionally, brokers in Brazil are obligated to provide information by every client. That means a Ponzi scheme like the one orchestrated by Bernie Madoff would never have worked in Brazil.

Retail Remains Resilient

Just as Brazil’s regulators have taken their cues from past mistakes, Brazil’s growing middle class – which now encompasses more than half the country’s population – has been hardened by tough times and proven resilient throughout the current crisis.

May retail sales advanced at an annual pace of 4% and June sales are expected to have increased by 6.5% year-over-year. Furthermore, an IBGE survey showed that nine out of 10 retail sectors showed month-on-month sales increases.

“Brazil has had so many crises over the years, people got used to them,” David Neeleman, the founder of JetBlue (Nasdaq: JBLU), who last December started a low-cost Brazilian airline called Azul told BusinessWeek. “I don’t think they’re at all fazed by this crisis-everyone seems to be focused on buying their first car, getting their first credit card.”

Credit card purchases have grown by 22% a year over the past decade, BusinessWeek reported.

However, Brazilian consumers also got a helping hand from the government, which cut income taxes and reduced levies on a wide range of durable goods.

In April, the government cut taxes on construction materials, cars, and household appliances. The end result was a 5.7% rise in spending on construction materials in May and an 8% surge in auto sales.  Rejuvenated auto sales hit a record-high 300,000 in June.

And increased sales led to increased production. Industrial output rose for the six straight month in June, climbing 0.2% on a monthly basis.

“Brazil has proved it can govern itself and keep the economy on track in very difficult times,” Riordan Roett, a professor at Johns Hopkins University’s School of Advanced International Studies, told BusinessWeek.

Buying Into Brazil

Brazil has also proven that it has a strong consumer base of its own ready and able to fuel economic growth, even as exports falter. In fact, exports account for a mere 12% of Brazil’s $1.5 trillion economy.

From 2001 to 2007, the poorest 10% of the population enjoyed a 49% increase in real income, Brazilian economist Marcelo Neri told the Miami Herald, describing what he called “Chinese-like growth.”

Roughly 27.8 million Brazilians – out of a population of nearly 200 million – joined the consumer economy from October 2003 to October 2008, according to Neri.

About  8 million jobs have been created in that time, while the minimum wage has increased 45%

That makes Brazil a very attractive destination for investment.

In an April Buy/Sell/Hold column, Money Morning contributing editor and emerging markets specialist, Horacio Marquez, recommended Petroleo Brasileiro (NYSE ADR: PBR) for several reasons – the rising prices of oil in the next few years, the discoveries of large oil fields off Brazil’s shore, and increase local demand from the country’s growing population and income levels.

Another commodity play is Vale S.A. (NYSE ADR: VALE), the world’s largest iron ore exporter and a key supplier to China’s exuberant infrastructure expansion. Vale will benefit not only from increase in demand when global economies (and trade with them) recover, but also the rebound of commodity prices across the board.

Martin Hutchinson, another Money Morning contributor, recommends Companhia de Saneamento Basico, orSabesp (ADR: SBS), which operates the water-and-sewage system for Brazil’s Sao Paulo region. Sabesp currently has a P/E ratio of 6.92.

“Now that’s a growth business, and one that’s not dependent on commodity prices,” he said.

Finally, the iShares MSCI Brazil Index ETF (NYSE: EWZ) has been recommended by both Marquez and Hutchinson. The ETF aims to measure the performance of the Brazilian equity market. It has net assets of $8.58 billion, a Price/Earnings (P/E) ratio of 12.75, and a dividend yield of 3.66%.

This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.

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