Insights & Advice

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Brazil—not for the faint of heart

Beset by scandals that could reach as high as the presidential office, suffering from an epic drought, low oil prices, high inflation, a declining currency and a negative economic growth rate, the world’s seventh largest economy could be an interesting long-term investment but not for the faint of heart.Brazil

No question about it, Brazil is a basket case right now. Dilma Rousseff, the two-term Brazilian President and former head of the state-owned energy behemoth, Petrobras, is embroiled in scandal. So far she has managed to elude prosecutors, who are pursuing 28 different investigations involving 54 politicians. Present and former Petrobras executives, including heads of both Chambers of Congress, former ministers, an ex-president, as well as the top members of President Rousseff’s ruling Worker’s Party are all involved.

The multi-billion dollar kickback scandal involved funneling money through Petrobras and into the pockets of politicians and the election coffers of the Worker’s Party from 2003-2010, (when Rousseff was president of the company). She maintains no knowledge of the scheme, however, three out of four Brazilians think she is lying and 44% of the population disapproves of her administration. Business and consumer confidence are touching historic lows while the Brazilian currency, called the Real, has depreciated 40% against the dollar.

Brazil is also suffering from a wide-spread and lingering drought that is hurting their vast agricultural export sector (3.5% of GDP and employs 15% of the labor force). It gets worse. The country’s main source of energy is derived from hydroelectric plants, which depends solely upon water to drive their industrial sector (23% of GDP). As a commodity-rich country, the decline of that sector over the last few years has crippled growth. Yet, government spending continued to climb while much-needed and long-postponed structural reform of the country’s rigid labor laws continued to be ignored.

As a result, economists forecast that debt as a percentage of GDP will end the year at 65.2%, while the economy will see a -1.5% decline in GDP growth. Inflation could reach as high as 7.5%. In the face of all this terrible news, why am I recommending buying?

Brazil’s stock market has always had a boom or bust element to it. My first visit to Brazil was during the “Lost Decade” of the 80s when the condition of most Latin American countries resembled those of present-day Greece. Needless to say, Brazil’s stock market was a total bust. The Bovespa, (Brazil’s major index) reached a low in December of 1989.

By the early 1990s, however, thanks to a massive debt-for-equity swap by its bank creditors, the country’s investment prospects greatly improved. During the 1990s, the market experienced sizable gains for investors, as well as major losses. Another market low was registered in 2002. At that time (unlike today) investors feared the country would default on their debt, which was far worse. Foreign reserves were also much lower, inflation was higher and the pressure on the Real was greater.

Worst of all, Lula de Silva, a radically liberal candidate of the Worker’s Party, was elected president. That horrified the country’s financial markets, who believed he would lead the country into a socialistic ruin. “Lula” did the opposite. He took severe measures, with the aid of the central bank, to control inflation, while imposing market-friendly policies and structural reforms. As a result, the Bovespa registered a 250% gain from 2003-2004. In the next eight years the stock market was up 1,705% versus a 57% increase in the S&P 500 Index. At that point the financial crisis drove the market down and it has never really recovered.

Today, I sense that investors’ fear may be approaching the level that prevailed back in 2002. And yet, the economic conditions in Brazil are far better today. Some say the commodity cycle has bottomed and so have oil prices. If so, that would be a big shot in the arm for Brazil.

I do know that the U.S. is the country’s second largest trading partner and the strong dollar benefits Brazil’s exports. The political scandals may topple the president, in which case there is a distinct possibility that a new administration would implement “Lula”-like reforms to jump-start the economy and restore both business and consumer confidence. As for the drought, who knows when the weather will change?

Will all of this happen overnight? Not likely, but for those long-term investors that have the risk-tolerance and patience to wait, Brazil seems like an interesting place to nibble.

Posted in A Few Dollars More, Investment Portfolios