Alex Muromcew, Managing Director, Active Emerging Markets Strategy
The value of Brazil's stock market more than tripled from 2000 to 2011—one of the best performances in Latin America. The first part of 2012, however, has been a challenging time to hold Brazilian stocks, and especially hard on those holding a broad-based country index. Stocks on the Bovespa index have dropped 2.4% year to date in local currency. One of the reasons is that Brazilian stocks have been caught up in investor nervousness over the eurozone and its sovereign debt crisis, which has slowed the flow of capital into foreign markets everywhere, including Brazil. But Brazil also has some challenges it has created on its own, through its economic and regulatory policies. The question is how to steer clear of the problem areas and capitalize on the country's considerable strengths.
So far in 2012, investors would have been best off selecting individual Brazilian stocks in certain sectors that are performing well, such as engineering and construction, rather than investing in the broader market. Consider, for example, the performance of select construction and engineering companies in 2012 compared to the Bovespa index (see Exhibit 1). The dynamics of the current Brazilian market are such that this will remain true for the foreseeable future.
Select Companies Outperform the Bovespa Index
Source: Credit Suisse
An economy with many assets
Despite its challenges, Brazil holds a lot of promise for investors. It is the sixth-largest economy in the world. Brazilian stocks are inexpensive; the Bovespa index has a price-earnings ratio of 9.9 against expected 2012 earnings. Energy and materials companies (particularly state-owned oil company Petrobras and mining company Vale) are critical contributors to the economy, accounting for 35% of the index. Petrobras made several huge oil-field discoveries in 2007 and 2008, which it is now working to develop. Brazil also has extensive natural resources in the area of iron ore, which is one of its biggest export products. Demand from China—Brazil's biggest trading partner—for iron ore, soybeans and other products has brought jobs and higher wages to Brazil's domestic economy.1 Yet one of the most attractive things about Brazil is that it isn't dependent on exports because of its large middle class with buying power. As the country's president, Dilma Rousseff, said in a speech this past spring, "Brazil is 100%, 200%, 300% prepared" to grow even in a sluggish world economy.2
The problem is that Brazil’s economic resilience hasn't been much in evidence lately. The country's GDP growth has been slower than expected this year (and slower than that of other Latin American countries), with household consumption barely growing and dry weather hurting the agriculture sector.3 Meanwhile, the Central Bank's moves to lower interest rates—which have come down about four percentage points between the summer of 2011 and the summer of 2012—don't seem to have done anything to spur the economy. Instead—in a country where inflationary flare-ups have led to big stock-market selloffs—the interest-rate decline may have spooked investors. In addition, banking sector profits have been hurt by recent government pressure on banks to reduce the spreads they receive on consumer lending.
Betting on infrastructure development
Two industries that have a lot of upside at the moment are construction and engineering. The companies in these industries have limited competition and are benefitting from Brazil's need to upgrade its infrastructure. In recent years Brazil has underinvested in infrastructure, including ports, highways and roads; the 2% of GDP that it spends developing its infrastructure is about half the level of other Latin American countries. The new infrastructure Brazil needs to keep its energy and mining industries growing—and that it is currently building for the 2014 Soccer World Cup and the 2016 Summer Olympics, to be held in Brazil—give these industries a lot of earnings visibility.
In short, even with the market in Brazil no longer rising inexorably, there is still a lot of money to be made. For now, success is likeliest to accrue to those who use a bottom-up strategy to pick sectors and individual stocks that have high earnings potential and low exposure to government regulation. Domestically oriented manufacturing, construction and materials companies are among the best bets. In a scan of Brazil's investment opportunities, these stand out as making sense both now and for the long term.
Brazil's currency challenges
Another challenge is the recent volatility of Brazil's currency, the real. Worried that the real's strength would hurt Brazil's export business, the Brazilian government has taken steps this year to lower its value against the dollar. But the real's sudden decline has made it hard for import- and export-oriented businesses to plan, and has saddled investors who are U.S. dollar-based with big currency-related losses, at least on paper. (The 2.4 % drop in the Bovespa so far this year translates into an 11.3% decline for U.S. dollar-based investors.)
Because of the uncertainty surrounding the real, our current investment philosophy in Brazil is to avoid businesses that are too dependent on exports. That has prompted us to limit our holdings in metal and mining companies, which face additional pressure because of a decline in commodity prices. On the other hand, we are overweight in some domestically oriented parts of Brazil's industrial sector, including manufacturing and processing. There, we expect growth because of Brazil's relatively wealthy population. About 50% of the country is middle-class—the highest level in Latin America.
Brazil rewards bottom-up stock-picking, in a way that isn't always true of other emerging markets, like Colombia or Peru. Where stocks tend to be very directional in smaller emerging markets—moving up or down across the board—Brazilian stocks are much more apt to diverge based on the prospects of particular industries. And there is a lot to choose from; Brazil's is a deep, broad stock market. There are significant opportunities for savvy investors that understand the market.
1 Wall Street Journal, June 22, 2012:
2 Wall Street Journal, May 22, 2012:
3 The Globe and Mail, June 1, 2012:
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Please note the risks associated with foreign investments are often magnified in emerging markets where there is greater potential for political, currency, and economic volatility.
Past performance is no guarantee of future results.
Investing involves risk of loss of principal.
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