New "Brazil bears" maul Bovespa stocks
For most of the last decade, Brazil's stock market was a virtual cash machine, rewarding investors who were seduced by a fast-growing BRIC economy with a stable of aggressive, seemingly world-class companies.
Yet, for all the hype, the Bovespa .BVSP is actually the worst performing index in the Americas this year, down a whopping 23.8 percent.
What happened? A series of Brazil-specific factors such as high inflation, political paralysis and the long-term prospect of rather unBRIC-like economic growth of around 4 percent have made the Bovespa especially vulnerable to the recent global equities selloff. The index looks likely to continue lagging its peers for months to come.
The Bovespa's decline to its lowest level in more than two years has made some investors wonder if the party that saw the index soar roughly five-fold from 2003 to 2010 has come to an end, at least for now.
Since 2007, the Bovespa is basically flat.
"In my conversations with investors all around the world, there's a new species in the forest which ... didn't exist six months ago: the hardcore Brazil bear," said Tony Volpon, head of emerging markets research Americas for Nomura.
"They call me up and say 'Brazil's going to blow, let's talk about when,'" Volpon said.
Volpon said he is not that pessimistic himself, and Brazil still has many things working in its favor.
Chief among them: Relatively low sovereign debt, a young emerging middle class, and economic growth that -- while lagging its peers in the BRIC emerging markets group, with India, Russia and China -- would still make most rich nations envious.
Yet, after the torrid 7.5 percent economic expansion in 2010, virtually no economists foresee a return to that level anytime soon. And there are signs the boom of recent years has created distortions that will continue to plague equities investors, in particular, in the medium term.
Data released on Friday showed the IPCA consumer price index rose 6.87 percent in the 12 months through July -- the fourth straight month above the central bank target of 4.5 percent, plus or minus 2 percentage points.
In response, the central bank has raised the benchmark Selic rate five times this year to 12.50 percent, up from 10.75 percent when President Dilma Rousseff took office on January 1.
That gives Brazil the highest interest rate among major economies, and the lack of progress on prices means that rates could stay higher, longer, than investors previously thought.
Recent data "is fanning beliefs that inflation-adjusted rates will remain rather high for a while," said Leonardo Kestelman, who manages $880 million in emerging market bonds for Dinosaur Securities in Sao Paulo.
Bonds vs Stocks: Kind of a No-Brainer
That leads to a simple question at the heart of the Bovespa's struggles: Which would investors rather have, a virtually guaranteed gain of 12.50 percent, or a potential loss of 23.8 percent? In other words, bonds versus stocks?
With Brazil's sovereign debt now rated investment grade among all three major agencies and the Selic rate so high, fixed income markets have siphoned investors from riskier equities, where investors don't see returns high enough to compensate for more expensive borrowing costs.
"Multi-asset fund managers have been going into fixed income more than equities," said Jason Press, a Latin American equities strategist with Citi.
By some technical measures, other countries such as Chile, China and India offer more attractive equity valuations.
The opportunity cost of missing above-average market returns in those three countries' equity markets is 15 percent, compared with 6 percent in Brazil, according to Thomson Reuters data. The opportunity cost is a concept in economics that measures the cost of the best alternative investment foregone.
Meanwhile, Brazil's economy has thrown up new red flags.
The real hit a 12-year high as recently as last week, and is considered by many including Goldman Sachs to be the world's most overvalued currency. That scares off many foreign investors who worry about losses in dollar terms in case the currency corrects in the near future.
Many economists have also become increasingly concerned about signs of a bubble in Brazil's consumer debt and real estate markets.
Also worrisome has been the policy response to the signs of overheating, including a tax on currency derivative trading that surprised markets last week.
That response and others have spooked investors, who don't know what other foreign exchange measures Finance Minister Guido Mantega could pull from his policy toolbox.
"We think that with so many regulatory measures seen over the past year, there are now distortions upon distortions," wrote Win Thin, global head of emerging markets strategy with Brown Brothers Harriman, in a note to clients.
"We are detecting increasing exasperation on the part of investors and banks with the arbitrary nature of these controls, along with the Law of Unintended Consequences."
Rousseff's Vision a Concern
In fact, the government's long-term vision overall has become a concern. Since taking office, Rousseff has failed to push the kind of sweeping changes to the tax code or labor laws that many investors say are needed to lift Brazil's economy back up to the 6 percent to 7 percent growth level.
Rousseff, a trained economist with no previous experience in elected office, has struggled with infighting among her own allies that has, in turn, paralyzed an already modest economic reform agenda.
There is "an absence of a more ambitious economic agenda to increase the competitiveness of the economy," noted Zeina Latif, an economist with Royal Bank of Scotland in Sao Paulo.
When Rousseff's government has acted, it has often been in a way that antagonizes equities investors.
Rousseff personally intervened in miner Vale (VALE5.SA) this year to pressure for the switch of the company's chief executive. Her government has also pushed state-run energy giant Petrobras (PETR4.SA) to keep retail gasoline prices low and take other initiatives that reduce profits.
That heavy hand, plus the government's relative ineffectiveness on the inflation front, has cooled the ardor of many investors who were previously excited about Brazil.
Otavio de Magalhaes Vieira, who oversees 1.3 billion reais in assets for Safdie Group in Sao Paulo, was blunt: "Markets have seen a less efficient government than we had hoped for before last year's election."
[Source: By Guillermo Parra-Bernal and Luciana Lopez, Reuters, Sao Paulo, 05Aug11]
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