Brazil has captured a lot of headlines so far in 2016. By some measures, Brazil's economy iscontracting at a pace not seen in a century; inflation is rampant; and corruption rife. However, aided by some external events such as a drop in the dollar and a corresponding rise in commodity prices, anticipation of political change (over the weekend, Brazil's lower house of Parliament, the Câmara dos Deputados, voted to impeach leftist president Dilma Rousseff) has propelled Brazil's stock market this year, and it's among the top performers year-to-date.
However, investors hoping for more gains should probably approach Brazil with caution. Though its CAPE ratio (see graphic below, courtesy of my friend, Isaac Presley) is among the lowest in the investment universe, inflation is around 10%, and some believe that figure is understated to relieve some pressure on the government. It's difficult to envision extended multiple expansion with such inflationary headwinds.
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Now, as many of you know, my wife is Brazilian, and I have traveled extensively through the country on multiple occasions. It is a lovely place, rich in resources, and populated by industrious and intelligent people. However, there are many obstacles to prosperity in Brazil.
Take, for example, government regulations. When I traveled to Brazil first in 2012, I toured some coffee and sugar plantations in the state of Parana. I was shocked to hear from the farmers that something as simple as cutting down a tree required government review and permission. Developing real estate requires the approval of many bureaucrats, and delays can take years for which many investors do not have patience. While these regulations were likely put in place as environmental protections, they are largely counter-productive, and almost certainly do more harm than good.
For would-be entrepreneurs, the requirements needed to open up shop are onerous. Capital is scarce, and credit can be difficult to obtain. For these reasons, Brazilians emphasize the importance of education so good-paying jobs are easier to get. However, because of a combination of the obstacles to entrepreneurship and the fear of failure, the most capable Brazilians either want to emigrate or find security in a government position. For these reasons, it is unlikely that those who will create the businesses of the future will seek to domicile in Brazil.
My last trip to Brazil was in November, 2015. On both the outgoing and return flights the airplanes were at half-capacity; the locals with whom I spoke, - and who had a realistic possibility to do so, - were researching ways to move to Europe, Canada, or the US.
So, while for both personal and humanitarian reasons I cheer any progress in Brazil, I will likely remain skeptical until real change occurs. It is not impossible; Argentina is embracing freer markets after years of Peronism, and neighboring Chile and Uruguay are thriving after instituting free market reforms.
Hopefully, the impeachment of a corrupt president is the start of a new chapter in Brazil.
The information provided above is obtained from publicly available sources and it is believed to be reliable. However, no representation or warranty is made as to its accuracy or completeness.