On last week’s cover of Baron’s is an article highlighting the long-term outlook for Brazil’s economy.
The article lists four big themes that should help the world’s 7th largest economy:
- Growing Middle Class – social mobility gives rise to domestic demand; positive trend in terms population that makes up middle and upper classes; young and growing population
- Healthy Banking System – high real interest rates curb malinvestment
- Stable Government – addressing a crumbling infrastructure (6% of roads paved) while preparing for the 2014 FIFA World Cup; large gap between interest rates and inflation rates allows room for rate cutting if need be
- Globally Focused Companies – a large amount of natural resources that are being exported to other countries (e.g. China)
While the stock market has struggled this year, GDP growth is expected to average 4% over the next three years. Further, a depressed stock market makes for more compelling valuations. It should also be noted that Foreign Investment ($60Bb) is 3x the amount 10 years ago.
I do think the article is compelling; however, there are still a few items of which I am wary:
- How dependent on China is Brazil’s economy? If China has a hard landing, what will the impact be? Note: 32% of the stock market, but just 3% of the economy is commodity based.
- There are still slums (I recall hearing some of the worst in the world) and a high poverty rate, begs a risk of social unrest?
- Highest corporate taxes in emerging markets (34%).
- An unraveling in Europe could derail the growth story.
- Currency is still volatile. The Real depreciated 60% versus USD in 2008. If risk returns to credit markets you could see a large drop as investors flock to the dollar.
Ultimately I think the risk/reward here makes a compelling reason to like Brazil. Perhaps the biggest reason for optimism was the quote by Alan Vinson at the end of the article: “The average Brazilian is very optimistic”. Optimism amongst its citizens provides fuel and lends credence to the abovementioned positive trends.
