The Brazil election, the Bovespa and the dollar

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The Brazil election, the Bovespa and the dollar

Aecio Neves’s pro-reform agenda includes central bank inflation targets, fiscal discipline and a free-float for the real.

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Published: Mon 27 Oct 2014, 1:25 PM

Last updated: Fri 3 Apr 2015, 7:09 PM

The US dollar’s strength is a disaster for commodities and emerging markets equities, exactly as in the Clinton era in the late 1990s or the pre-Plaza Accord Reagan first term. Could this be a secular, multi-year rally in the US dollar? Yes, I think so. Why? The US economy is accelerating while Europe is haunted by deflation risk and China is in a economic morass. The US dollar has had a spectacular rise against the Japanese yen, the euro, the Indian rupee, Brazilian real, Russian rouble, Canadian dollar and South African rand over the past two years. However, the dollar’s steep rise against the euro in 2014 has spiked the US Dollar Index sharply higher. It is all too possible that the US jobless rate will fall to five per cent in the next eight months, making a Fed rate hike inevitable even while the ECB and the Bank of Japan are forced to increase their “easy money” policies. This policy divergence among the Big Three central banks mean the strong dollar’s trend momentum will be reinforced. After all, US equities now trade at a 38 per cent premium to emerging markets equities, meaning Wall Street has priced in a secular strong dollar trend.

Dr Arminio Fraga, Brazil’s leading economist, hedge fund manager in Sao Paulo and the architect of the Real Plan will be the next finance minister of Brazil if Senhor Neves wins this weekend’s Presidential election. This will be a game-changer event in the history of Brazil and Latin America since his agenda is pro-reform, pro-markets and pro-deregulation. Like India before Modi or Indonesia before Widodo, elections could be the catalyst for a major stock market rally in Brazil. Brazil has been plagued with anemic growth, high inflation, a 3.7 per cent current account deficit, price controls by the ruling Workers Party and a huge credibility problem in international financial markets?

So it ones not surprise me that Brazil equities trade at 10 times earnings, a significant discount to India’s 16.4 times earnings. Of course, the time to own Brazil was in mid-May to mid-August, when the Bovespa rose a fabulous 20 per cent, mainly on hopes that Dilma Rousseff’s regime will lose power in the lection.

Aecio Neves’s pro-reform agenda includes central bank inflation targets, fiscal discipline and a free-float for the real. I am not bullish about the real but there could be a major market bull run if Neves wins the election this weekend. The real has depreciated 25 per cent against the US dollar since 2011, similar to the secular fall in the Indian rupee. However, unlike the Sensex, the Bovespa has fallen 10 per cent since 2011. Unlike India, Brazil suffers from commodities bear markets. While lower crude oil benefits India, lower soybean and iron ore is a disaster for Brazil. Still, if Neves wins, Brazil is a no-brainer buy.

Brazil is not expensive at 10 times earnings, 1.3 times book value and 4.5 per cent dividend growth. However, GDP growth is flat in 2014, as are corporate earnings. Inflation is six per cent. The real is 2.48 but I believe it can fall to 2.60 in the next three months if the bloodbath in commodities continues. The land of samba, Copacabana, Carnival and Ronaldo is the world’s seventh-largest economy. A win for Neves would change the fate of Brazil. So I hope my old Wharton professor Dr Fraga is the next finance minister of Brazil. With Neves and Fraga, Brazil shares will soar.

It is a pity that populist demagogues like Hugo Chavez, Fidel Castro and the Peronists in Argentina have so mismanaged Latin America’s economies. Rousseff is a former Marxist guerilla who praises Castro and Chavez. Her economic record was a disaster. If Neves wins, Petrobras could rise by 15 per cent next week.

Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae



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