Verde Asset Management letter for the month of March 2016. Translated from Portuguese.
When drowning, alligator looks like a log.
In the report we wrote at the end of November last year, we were completing the following:
“In summary, we are very negative with Brazil by the foundation. However, our portfolio is not so pessimistic so for three reasons:
The. Already has a lot on current prices;
B. There is a risk if the impeachment occurs, cause a bull market, although not sustainable;
c. Foreigners are constructive vision and position for Brazil.
In conclusion, we are positioned for muddle through, but with various insurance catastrophe protecting us from a non-negative linearity. ”
In 2016, the markets came against our positions on various fronts. We split into 3 themes.
Verde Asset Management – The dollar weakened in the world
First, at the global level, we had a significant increase in the fear of a more recessive process in the US, initiated by the weakness in the manufacturing and oil exploration sector. The fear was that a recession was right there around the corner. Before long, the topic that won the markets was again the global recession, with legs in the US, Europe, Japan and China. Quickly, the world’s central banks have engaged in more easing, each to his style. In the US, in particular, despite the fact that the employment data continued surprising upward, and the inflation also the reversal of monetary policy was intense. In this context, the dollar has lost a lot of value, and there was a reasonable mood improvement for emerging countries, especially high yield. Brazil came in the same boat, and the exchange ended up valuing the period for global reasons, notably in relation to the change in the Fed’s stance.
That is, from the point of view of the conclusion of the November report, the point (c) strengthened and the degree of courage with Brazil and other emerging rose. Does the strong dollar turned world history? It still seems unlikely, since looking at the countries in the world, the United States are those who are in relatively better conditions, more robust growth, financial system better capitalized and less leveraged in a more advanced stage of the economic cycle, so that inflation pressures appear there first than elsewhere and monetary policy will (sooner or later) reflect this reality. The abrupt changes in monetary policy signaling in the US seems inconsistent with the real state of the economy (employment and inflation).
Verde Asset Management – Politics, politics, politics …
The international component was relevant in the first quarter of the year, certainly, but, of course, was not the most relevant. The most important were the consequences of the policy. Specifically, no we’ve been working with impeachment scenario as the most likely, although the economy was in catastrophic situation, along with the public accounts. And to a large extent our perception came from the fact that any impeachment process is institutionally very difficult to be realized, requiring 2/3 of the Chamber of Deputies, in a context where the true ideological core of the government was close to 100 members, a base that at least it was officially composed of several parties, all awarded positions. Moreover, it has not yet managed to defeat the government in the Chamber of Deputies with impeachment score.
That is, at first, seemed less likely, a month ago, the entire center of the ring arc jumping the fence in the proportion that could cause the impeachment became viable. Just for illustration purposes, it is responsible for checking the degree of fidelity of the base in the Chamber of Deputies. The graph below shows the degree of fidelity of all deputies in the 240 votes that took place on the 2nd Rousseff’s tenure with open votes. In these polls, 92 MPs were loyal to the government 90% of the votes – that is, this group of 92 MPs only voted in favor of the government in 10% of projects – 145 deputies voted in favor of the government in more than 85% of votes , ie a strong degree of fidelity. In those same votes, 273 MPs voted for the government in more than 75% of votes. It is clear that there is a great mass of members, distributed in several parties, with a high degree of loyalty to the government. In this way, the principle would be difficult to approve a request for impeachment.
Behold, the Lava jet produced its major breakthroughs, first with the tipoff of Delcídio Amaral, leading to the ropes government, and soon after the forceful Lula, who eventually inflate relevantly Day demonstrations the 13 of March. The government outlined a reaction, to try to name the 1st Lula government minister, with the explicit function to reorganize the troops against the impeachment, and breaking win a privileged forum. And then he again Moro, decided on a bold move to lift the secrecy on wiretaps of Lula, who in a “fortuitous” captured Dilma Lula on the date of appointment to minister. It was the bomb that was needed to implode once the PT’s strategy to reorganize and fight the impeachment, and the rout of the base “ally” began. In this sense, we were bowled over by Moro.
Thus, in less than 2 weeks, the impeachment went unlikely to viable, and the prices of assets in Brazil had a significant improvement on this new perspective. The height of the impeachment favorable perception occurred in government PMDB landing, imagined it was dragging the other parties of the base. But this was not confirmed yet. The Stampede PMDB proved a mistake in its strategy (whether fatal or not, we shall see shortly), returning to the government offices, with a reasonable time to trade them with other parties “Centrão” in order to convince them to stay . It remains reasonable time for new facts change the course of history, as any manifestations and new phases of Lava Jato, or even vigilantism already in negotiations. However, it is recognized that the situation today is far from clear and certain.
Being approved the impeachment, it will be the Temer build a nonpartisan government of notables, to try to get away from the problems of Lava Jet and rebuild the economy from the rubble, and from this time, advances in asset prices will be a function of delivery of reforms relation to the expected, with still significant risks governance dictated by the disintegration of the political establishment promoted by Lava jet, which will remain active.
Verde Asset Management – Advances in Brazil’s external accounts
Last but not least, we had a significant improvement in the current account deficit, largely because the strong recession, which caused a collapse in imports (much less permanent, given that since the activity stops contracting imports return to rise). Earlier this year, we had been estimating a deficit on current account in the vicinity of $ 20 billion in the year, with a trade balance of US $ 40bi order. It is clearly seen by the graphs below that the evolution of the external accounts has been more favorable, very on top of the fall in imports. Anyway, the annualized deficit of the last 3 months is running close to $ 10 billion.
Still in the external accounts, direct investment in Brazil not only remained high, as indeed increased by US $ in recent months – unprecedented in Brazilian crises. The chart below shows this evolution of Foreign Investment. This is something quite surprising, given that we are in the worst recession of the republican history of Brazil, with a cumulative decline in GDP per capita of more than 10% in the three years 2014-2016, with a strong contraction of profit margins economy.
Verde Asset Management – In conclusion
In the end, each point above helped improve asset prices in Brazil, going in the opposite direction to what we believed. We understand that the advance of impeachment may also bring some optimism legs, as it materializes, and that the ministerial team that will eventually be indicated is actually remarkable, able to restore some of the economic order.
Brazilian fundamentals, especially tax, remain extremely vulnerable, especially now that the tax no longer relevant from the point of view of the markets, to the extent that the only concern is the political question. We start from a primary negative recurring 1.5% of GDP and deteriorating, and we need to reach at least 2.5% to stabilize the public debt. Therefore, it will take several unpopular constitutional reform, in the light of today seem unlikely to pass in this war-torn political environment and in a context of active Lava jet. In a way, we go back to 2014 (setbacks
They turned the routine …): domestic economic fundamentals in worse, but a binary political issue ahead. After priced possible political transition, back to the cold cow. Without giving a significant improvement and structural, the country will resume the path of insolvency, contaminating risk premia, exchange rate and inflation.