A Short Note On Brazil’s House Of Cards

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A Short Note On Brazil’s House Of Cards: FIS Group Market Insights Alert – “The Brazilian Way”

Uniquely attractive entry points for long-term returns amid a political and economic crisis

PHILADELPHIA, PA, March 24, 2016 – FIS Group, a manager of U.S. and global developed, emerging and frontier markets equity portfolio strategies, today issued its latest Market Insights Alert, on Brazil’s political tensions, market turbulence, and economic disarray.

The Market Insights Alert entitled “A Short Note on Brazil’s House of Cards,” examines the political unrest surrounding the call for Brazilian President Dilma Rousseff’s impeachment and the country’s growing economic crisis.

“The political crisis in Brazil is largely the outgrowth of the economic downturn, and not vice versa,” said Tina Byles Williams, CEO and CIO of FIS Group. “Thus, we find the market’s reaction to Rousseff’s political plight to be little more than ‘irrational exuberance.'”

In the Alert, FIS Group provides a detailed timeline of the impeachment proceedings against Rousseff and weighs in on Brazil’s economic and market reaction to the unrest, including protests and a ‘constitutional crisis.’ Amidst the chaos, the Brazilian economy is still contracting, the property market is overextended, the fiscal drag is deepening, inflation is threatening to accelerate, and earnings continue to be stretched.

In addition to its Mark et Insights Alerts, which examine global economic themes and are published throughout the year, Ms. Byles Williams contributes to FIS Group’s Market Outlook series on a quarterly basis, based on research that examines market conditions over a three-to-six month period. The last Market Outlook was published in January 2016.

About FIS Group

FIS Group is an investment management firm that provides customized manager of managers investment solutions for institutional investors. For 19 years, we have delivered risk-adjusted returns by conquering the complexity of identifying high skill, high active share entrepreneurial managers that have gone largely undiscovered by the institutional investor community. Unique among our peers, FIS Group enhances risk-adjusted returns by using macro strategy insights to allocate capital among the managers and/or through a global macro tactical completion strategy. Our culture is a fusion of relentless curiosity and a scientific, disciplined process.

For more information please visit us at www.fisgroup.com.

A Short Note On Brazil’s House Of Cards

(A conversation between St. Peter and God on the seventh day of God’s creation of the earth)

St. Peter: My Lord, I marvel at all that you have created, but there is one land, to which I believe you have bestowed too much. [Pointing down at Brazil] You have created a land of temperate climate, fertile soil, endless fruits, unsurpassed beauty, abundant water, bountiful resources of all varieties, and yet free from hurricanes, volcanoes, earthquakes, tornadoes, tsunamis or other natural disasters. Why my Lord do you show so much favor to this one land?

The Lord: Ahhh, but you have not seen the people I shall give it!

Brazilians are famous (or at least stereotyped) for their supposedly laid back “tropical” attitude towards life. Generations of foreign visitors smitten by the profound beauty and docility of Brazil’s natural landscape have marveled at “the Brazilian way” (o jeitinho brasileiro) of managing what to outsiders appears to be a relaxed, happy-go-lucky life amid structural chaos, bureaucratic ineptitude, and economic disarray. The old and famous Brazilian joke cited above pokes fun at these seeming contradictions.

Today, Brazil is once again seemingly reminded of God’s evenhandedness.

The political crisis in Brazil has now exceeded any level of credibility for a realistic script in one of Brazil’s famous novelas (serial soap operas). In case you haven’t been watching this unfolding drama, here are some of the recent highlights (lowlights?). On Friday, March 4, former Brazilian President Luiz Inacio da Silva (“Lula”) was briefly detained for questioning by federal police in an obvious (and potentially desperate) political move by Sérgio Moro (“Moro”) the investigating prosecutor of the Lava Jato (Carwash) scandal enveloping the political classes of Brazil. In response to the political escalation, on Wednesday, March 16, Brazilian President Dilma Rousseff (“Dilma”) appointed Lula as her Chief of Staff (previously Dilma’s role under Lula) in a blatant move to place Lula outside of Moro’s jurisdiction for the Lava Jato investigations (Ministerial level appointments are subject only to the jurisdiction of Brazil’s Supreme Court). In response, Moro released a series of audio tapes obtained from wiretaps on Lula’s phone which, inter alia, confirmed the deliberate intent behind Dilma’s political machinations, while adding a rich trove of distinctly dodgy (not to mention explicit) conversations to the public record. On Thursday, March 17, amid protests both inside and outside the presidential palace in Brasilia, Lula was sworn in as Dilma’s Chief of Staff. Minutes later, a federal judge in Brasília issued an injunction against the appointment. Then on Friday, March 18 a separate federal judge annulled the injunction, putting Lula back on track to be sworn in (again). The case would now need to be resolved by a federal appeals court in what is being called by many foreign media outlets a “constitutional crisis”. Meanwhile, the largest street protests in at least 30 years continue in cities all across the vast country, generally calling for Dilma’s removal while the Brazilian Congress, which in the best of times makes the U.S. Congress look like a paragon of order and harmony, is plodding along with impeachment proceedings against Dilma (see the estimated timeline below, TABLE 1).

Strangely, perhaps in a sign of how bad things in Brazil had gotten, markets are seemingly buoyed by all this political absurdity. The inferred assumption of the market behavior is that all of this political chaos, must be hastening the demise of the Dilma/Lula/Workers’ Party regime which has led Brazil into its present recession (see CHART 1). In this thinking, all news that is bad for Dilma, is good for Brazilian assets. But it seems that the markets have a short memory. The political crisis in Brazil is largely the outgrowth of the economic downturn, and not vice versa (the Lava Jato investigation only really gained traction when Petrobras’ largesse dried up with the collapse in oil prices and the impeachment charges stem from Dilma’s attempts to use accounting tricks to hide the true size of the budget deficit). Thus, we find the market’s reaction to Dilma’s political plight to be little more than “irrational exuberance.” The Brazilian economy is still contracting, the property market is overextended, the fiscal drag is deepening, inflation is at least staying high if not threatening to accelerate, and earnings continue to be stretched (see CHARTS 2 THRU 5). Even if Dilma were ousted tomorrow, there is no outcome in at least the coming 12-24 months that would yield a political consensus that could reverse Brazil’s worsening fiscal trajectory. Even a substantial rebound in commodity prices would only offer a temporary reprieve for this stage of Brazil’s economic cycle, and such a reprieve might then only serve to buffet the Dilma government and thus again hurt market sentiment.

We are not chasing this wishful rally in Brazil. While we hope that the present crisis could ultimately yield an important turning point in Brazil’s political culture, we see any such change as manifesting itself tangibly very slowly. However, in such times of market turbulence, strong bottom-up stockpickers who can peel back the layers of disarray in the Brazilian market may be afforded uniquely attractive entry points for long term returns.



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