‘Thank God you’re all right.’
‘What was supposed to be wrong with me?’
‘I thought you’d been kidnapped.’
I was in São Paulo, Brazil, this month. I was hosted by Felipe Miranda, chief analyst with Empiricus in São Paulo, part of our worldwide network of analysts. Felipe went on:
‘I called the hotel. They said they hadn’t seen you. You know, we spread the word that you were coming because you’re giving a speech to investors. You’re advertised as a rich American investor. I figured that someone had found out where you were staying and thought it would be easy to kidnap you.’
I saw no signs of kidnapping or any other crime in São Paulo. I even dropped a two-real note on the ground, by accident. Someone picked it up…chased me down the street and gave it back. Then again, São Paulo’s Itaim Bibi neighbourhood is not exactly a favela. It’s more like Los Angeles’ downtown business district.
But crime is never far from the public mind. A friend’s uncle — the mayor of one of São Paulo’s huge cities within the city — was kidnapped five years ago. He died of a heart attack trying to escape.
Our partner’s car doors closed with a suspiciously heavy thud. ‘It’s armoured,’ he explained. ‘Bulletproof. Sometimes they stop you on the road. You’ve got to be able to back up fast.’
‘I was kidnapped twice,’ another São Paulista volunteered. ‘They get in your car…point a gun at your head and force you to drive to an ATM so you can give them money.’
We had lunch at Rubaiyat. It’s a well-known place, popular with politicians and businessmen. The beef is excellent — equal to the finest eateries of Buenos Aires.
Coming out, Felipe volunteered, ‘This is where one of our politicians was shot down. He has been taking money — a lot of money — from contractors. They didn’t want him to talk.’
‘Well, at least he had a good last meal,’ I said, always looking on the bright side.
The crowd’s opinion of Brazil
You probably think that Brazil is corrupt…
That it is a disorganized ‘Third World’ country. That it has an irresponsible left-wing government. That it is overly dependent on commodity prices. That now, with commodities — oil, grains, minerals — all down substantially, Brazil’s economy is suffering. That investments in Brazil have been lacklustre…or in actual decline…for the last six years. And that the country is now also suffering a huge drought that threatens its crop irrigation, as well as its hydroelectric power supplies.
All of that is true. But compared to the things that really matter, it is largely irrelevant. Or past tense. What matters when forecasting the long term performance of a stock market is debt, demography, and price.
Almost no one in Brazil has been paying into a pension plan as long as I have. The old tattered Social Security card in my wallet has no issue date on it. But the address tells us that it must have been issued before the ZIP Code system came out in the ‘60s. I must have had it when I got my first job — an usher at a movie theatre (both the theatre and the whole profession have disappeared) — at age 14. That would have been 1962.
It was a different world back then. The US still had a young, low-debt, high-growth economy. Social Security was still solvent. The dollar was still backed by gold. The idea of central bank financing of government expenditures was still seen as shocking and disastrous. ‘Printing money’ was considered to be the very thing the Fed was not supposed to do. Had William McChesney Martin, Fed chief during the Eisenhower years, proposed to hold the key lending rate at near zero for 70-plus months, he would have been regarded as a nutcase.
But age, not Fed policy, is what matters today. And the key feature of age, unlike Fed policy, is that it happens, no matter what you think.
You are nearer the beginning than the end of what has turned out to be a longish inquiry into what this means. Simply put, it means the ‘old countries’ — their assets and their institutions, at least the ones that depend on population, income and credit growth — are ‘fastened to a dying animal’ and are not likely to survive in their present form.
Of course, everybody knows our public pension and health programs are running out of money. But little has been said about how GDP, asset values, debt, and demography affect asset values and one another.
Those are the dots that I aim to connect today. When the picture is complete, you will see that Brazil is likely to be a better place for your long term investment money than the US is.
Opportunity in every difficulty
Falling prices of grains and other resources have hit the Brazilian economy hard. Mining, energy and agriculture are three of the country’s most important industries.
Even the weather has turned against Brazil. Although São Paulo’s epic drought is now over, industrialists and activists warn that fresh shortages may be just a matter of time. And since much of the country’s power comes from hydroelectric plants, a water shortage could prompt electricity rationing.
Crime is another hazard, of course. And so is inflation.
‘You can’t imagine how awful it was,’ began an eyewitness to Brazil’s hyperinflation of the 1980s. They continued:
‘You’d get paid and you had to go out immediately to spend your money. Prices were going crazy. You never knew what to expect. You couldn’t plan. There was no point in making a budget.
‘You wanted to make an investment or start a business? Forget it. The economy was falling apart.’
All the plans to stop inflation failed. Predictably, they began with a price freeze.
‘Disastrous,’ our witness reports. ‘Within hours, the merchandise had disappeared from the shop shelves.’
The price index rose approximately 1.6 trillion times from 1980 to 1997.
For the few investors with money in the stock market in the late ‘80s, it must have been one hell of a ride. The benchmark Bovespa index rose from nothing to around 50,000 today…with about a dozen zeros lopped off along the way. An investor would have gotten about the same thing in Brazilian stocks as in US stocks — a gain of about 15 times his money.
But there is one big difference. Brazilian stocks today are still cheap.
‘Brazil is still an emerging market,’ my host, Felipe, explained. ‘So it is more sensitive than the US. People become fearful and they take their money to the US When they are greedy, they come here.’
On the evidence, global investors are not especially greedy. You can buy the average Brazilian stock for just 8.2 times earnings, as tracked by Shiller’s CAPE. That’s a third of the US level.
Besides price, Brazil has demographics in its favour…
Relatively few people on the Rua Cachoeira can even remember the hyperinflation of the 1980s. Most of the people I pass on the sidewalk are under 40.
The oldest population in the world is Japan, with a median age of 44. The US median age is seven years younger. And Brazil is seven years younger still.
And it’s also more solvent, with a debt-to-GDP ratio of 66%, compared to 104% in the U.S.
‘Brazil has a young population,’ Felipe says. ‘We want to make money. We don’t want government to get in the way.’
After the extreme disruption of the 1980–97 period, Brazil enjoyed two decades of growth and relative stability. Fernando Cardoso’s new currency was steadfast. The economy was still booming when Lula da Silva took over.
‘Lula was smart,’ Felipe tells me. ‘He appealed to the left and he spent more money. But he left the economy in working order. By 2010, the unemployment rate had fallen to just 5%.’
Dilma Rousseff was either less competent or less smart, depending on who you talk to. Indisputably, she shifted the economy toward a more crony-oriented capitalism. Government borrowing increased. Social programs became more expensive. Now, the deficit is running at nearly 11% of GDP. The current account deficit is another 3%. Together, that’s a 14% deficit.
‘Dilma is fundamentally a Keynesian,’ Felipe concludes… ‘She stimulated the economy, though unemployment was only 6%. Government spending has gone up to 20% of GDP. And consumer price inflation has gone up to 10%.’
But now, Dilma is out while the legislature sorts through her impeachment. Stepping into her place with what promises to be a more market-friendly government is former vice president — now acting president — Michel Temer.
Rodolfo Amstalden, one of our top ‘big picture’ analysts in Brazil gives us the local view: ‘Temer has the chance to produce huge economic gains with only a few steps, even in a short period.’
Hurry up and wait
For a Brazilian, Felipe and his team think they know just what to do: Buy an inflation-indexed bond — an NTNB — with an inflation-protected yield of 6.3%. For a foreigner, there is an additional risk — the currency risk. Felipe says:
‘The carry traders are borrowing cheap in the US or Japan…buying these bonds…and hedging the currency risk with futures. It’s working out well for them. Especially for the Japanese. They’re getting a good net yield, plus they’re making money on the falling yen.’
‘But it’s not something for most investors.’
‘So what should my readers do?’ I ask on your behalf.
‘Wait. This is another situation similar to what Paul Volcker faced in the US in 1980. You had an inflation rate of 13%. Volcker had to get ahead of it. And he was extremely unpopular at the time.
‘But Reagan stuck with him. And he turned it around. You then had the biggest bull market of all time…starting with stocks trading at barely five times earnings in 1982…up to 43 times earnings in 1999. That was the time to get in and stay in.
‘A repeat of that is almost impossible in the US today. You need high interest rates and low stock prices to make it work. And we have that in Brazil.’
For Markets and Money, Australia