SLOWDOWN IN BRAZIL
ED KUCZMA, EMERGING MARKETS ANALYST: Global economic growth is slowing across the world. The U.S. is coming out of its own crisis; the European Union is dealing with its own financial crisis; and China's starting to decelerate from its ambitious growth targets achieved in the last part of the 2000 decade. Going forward, I think Brazil is not going to be immune to a global slowdown as they are a large exporter of commodities. They are very dependent on iron ore, pulp and paper, and agricultural commodities. With the fall-off in commodity prices, this should be sort of a drag on their economy. I think Brazil's also going through somewhat of a Dutch disease, which refers to an economic term characterized by the Netherlands' economy in the late sixties and seventies, where a boom in natural resources helped the currency to appreciate, driving out other competitive sectors within the economy, namely industrial and manufacturing sectors. As the currency appreciated, it made exports, mainly in manufacturing, less competitive on a global scale. Also, as the currency appreciated, domestic demand for import increased. This decreases the competitive nature of the industrial economy, which is another driver for the economy. Overall, I'd say a weakness in commodities exports and the industrial sectors is starting to have a toll on the Brazilian economy.
Brazil is going through this theme of a two-speed economy. There is a decreased demand for exports in natural resources, which has kind of been a drag on the economy recently, and there is the faster speed, domestic consumption, which has been driving the Brazilian economy. Brazil's benefitted from having historically low unemployment rates — the economy's basically at full employment — and also from low interest rates, which makes personal loans a lot more affordable for the general public. Additionally, there has been a dramatic shift in demographics where a lot of people have migrated from the bottom part of the socio-economic pyramid up into the emerging middle class. All of these factors have positive implications for domestic demand within Brazil, and that's what's really driving the economy lately. If you're looking as an investor to try to take advantage of these opportunities, I think you’ll want to look at the small-caps, because that's where you’ll find supermarkets, beverage makers, processed food makers and service providers that are not as in tune to the global economic cycle and are more in tune with the local Brazilian demand story that most investors think about when they're looking to invest in emerging markets.
SHIFT TO LOWER INTEREST RATE REGIME
Benchmark interest rates in Brazil have come down dramatically from a high of about 18% or 19% to around 8.5% currently, and they're forecasted to go lower. I think this has three major implications for investors. One, you should start to see the so-called "carry trade" start to unwind, where investors borrow money in the U.S. at low interest rates and invest the money in Brazil in relatively safe government securities, yielding high interest rates. Secondly, you should start to see a shift in institutional investors' allocations from, again, low-risk, high-yielding government fixed income, into more risky, but also higher earnings yield equity investments. Thirdly, I think there will be direct consequences toward investment and domestic consumption in Brazil as companies and individuals are able to take out loans at attractive interest rates. This reduces the borrowing cost for companies and individuals. Just as an example, mortgages to GDP in Brazil are around 4.5%. This is in stark contrast to developed markets, where mortgages to GDP is close to 100%. This should have a strong multiplier effect as local Brazilians start to invest in their homes and start to consume more. I think this has very significant implications for domestic consumption overall.
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