Several exciting developments that bode well for Brazilian stocks may be going largely unnoticed by investors outside the country.
The global financial sector reflects a maelstrom of news headlines, from corporate-, sector- and industry-specific to macroeconomic and geopolitical in nature. Amid enormous flows of information, the focus is drawn to certain high-profile issues -- and less eye-catching developments can sometimes slip through the net. One of these is the good news story around the growth of equity investing in the Brazilian asset management industry.
Brazil is a country that has experienced most of the economic scenarios students learn about in their economics classes. Most citizens can still remember when inflation was a problem. Although it peaked in 1990 at 2,947%1, it wasn’t until 20042 that it fell (and remained) below double figures. Back in the early 1990s, shopkeepers would alter their prices twice a day. People were being paid twice a week, to afford the food prices at the shops.
Wages, rents, pensions, all were indexed to inflation. Brazilians preferred to take the bus than the taxi, because you pay for your bus ticket up front. In a taxi, the driver would take out a calculator at the destination and tell you how much more you had to pay, over and above what the meter said, because of the prevailing rate of inflation.
Source: OECD as at 24 October 2019. Inflation (CPI) (indicator). doi: 10.1787/eee82e6e-en. Logarithmic scale used. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Since 2004, headline inflation has remained in single figures, taking a notable turn downwards when the recession hit in 2015/16. The September 2019 level of 2.89%3 represents an historic low, which has driven market expectations of interest rates down, to levels of 4% to 4.5% by December 2019. As always in emerging markets, the biggest beneficiaries of falling (and stable) inflation are the people at the bottom of the socio-economic ladder; unlike the wealthy, they are uniquely 'unhedged' and should feel the improvement in spending power very quickly. This development bodes well for the lower end consumption plays in Brazil.
The equity phenomenon
Meanwhile, the Brazilian asset management industry has been growing apace. Partly due to legislation changes over time and partly due to economic growth, assets under management breached $1 trillion in 2018, hitting $1.1 trillion in June 2019. This represents a compound annual growth rate of 144% over the last 10 years.
Source: ANBIMA Investment Funds Bulletin as at 30 September 2019. All data in US$. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Alongside this exponential growth rate in assets under management, the corresponding numbers for investment in domestic equity has kept pace. Assets invested in the Sao Paulo stock exchange in 2000 were $19.5bn. As at June 2019, the number was $128.8bn4.
Effectively, Brazilian investors, who have grown up on a diet of high real (inflation-adjusted) interest rates relative to the rest of the world, are now faced with a novel choice: Get used to lower returns or diversify. They’re choosing to diversify, by increasing their allocation into equities.
One group of investors who appear to have missed this development are foreign investors.
Dedicated Emerging Markets investors are currently at a moderate (1.4%) overweight5 compared to the MSCI EM index position of 7.55%6. According to Morgan Stanley Research7, this weighting is below the 5-year average of +1.6%, let alone the maximum of +2.3%. Whilst not a demonstration of international investors' lack of interest in the Sao Paulo Bolsa, it seems to indicate that there is room for higher allocations.
One potential catalyst could be the passage of the pension fund reforms in the Brazilian Senate, which happened on 24th October. Investors now begin to attach credence to the projected tax reform, involving a unified federal VAT rate, which would be incrementally positive for the government’s fiscal outlook.
The latest data from the Brazilian Financial and Capital Markets Association suggests that domestic equity flows are $11.7bn8 for the first nine months of 2019, with $1.8bn in September alone. Foreign investors have probably invested a fraction of that amount.
Brazil is relatively well placed amid US-China trade tensions. Its soybean farmers have been standout winners for the last two years, as the $15bn annual US exports to China have been switched to Brazil and to a lesser extent, Argentina. Furthermore, President Bolsonaro's first State visit to Beijing (on the same day that pension reform passed in Brasilia) demonstrates the value placed on a good China relationship. No coincidence that Huawei has not been barred in Brazil and the company has committed to open an $800m factory in the country, to produce 5G base stations. An opportunity reveals itself.
1 Source: FactSet and OECD as 24 October 2019.
2 FactSet and OECD as 24 October 2019.
3 Source: Banco Central Do Brasil as at 24 October 2019. https://www.bcb.gov.br/en#!/c/news/
4 ANBIMA Investment Funds Bulletin as at 30 September 2019.
5 Source: Morgan Stanley Research, Weekly Fund Flows, 18 October 2019.
6 Source: MSCI as at 30 September 2019. MSCI Emerging Markets index.
7 Source: Morgan Stanley Research, Weekly Fund Flows report 24 October 2019.
8 ANBIMA Investment Funds Bulletin as at 30 September 2019.
5G is the fifth generation of cellular network technology.
Brasília is the federal capital of Brazil and seat of government of the Federal District.
The Brazilian Financial and Capital Markets Association has the purpose of representing and defending the interests of more than 300 members including banks, asset managers, brokers, securities dealers and investment advisers, which reflects the plurality and independence of the association. It works for the representation and coordination of its members' interests, locally and internationally, and is dedicated to the development of a stronger capital market in Brazil.
Consumer Price Indexes (CPI) measure the average change in consumer prices over time in a fixed market basket of goods and services.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
The MSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The São Paolo Stock Exchange (SAO.SA) is based in São Paolo, Brazil. Originally founded in the year 1890, this vital stock exchange is the fourth-largest by market capitalization, in all of the Americas. It is the 13th largest exchange in the world. The SAO was formerly known as the BM&F Bovespa and now identified by the acronym B3.
A value added tax (VAT) is a type of consumption tax that is placed on a product whenever value is added at a stage of production and at final sale. The amount of value-added tax that the user pays is the cost of the product, less any of the costs of materials used in the product that have already been taxed.