Monday, January 5, 2015

Each January, investors start scouring for bargains, and, at first blush, the beaten-down Brazilian stock market seems to offer some fertile hunting ground.

In early May 2008, the Bovespa stock index achieved a peak of 72,593. By the end of 2014, this broad basket of Brazilian stocks had declined 33 percent to 48,512. Measured in strengthening U.S. dollars, the decline was far worse, especially considering that the Dow Jones average appreciated 38 percent during the same period.

Is it time now to buy Brazilian equities?

Investor Warren Buffett is fond of considering the relationship between the market value of publicly traded equities and a country’s economic output as one early measure for evaluating whether stock price levels signal buy or sell.

At the end of 2013, the last period for which comparable data are available, the market value of Brazil’s publicly traded shares totaled $1.2 trillion — just 56 percent of Brazil’s gross domestic product. By contrast, the market value of publicly traded equities in the U.S. was $18.7 trillion, or 112 percent of annual economic output.

At surface level, Brazilian common shares seem undervalued, but what do other metrics tell us?

Though national politicians profess otherwise, the most important driver of enduring economic value is increasing incomes that are earned by serving needs of private-sector customers. Unless we are blindsided by geopolitical events, structural oversupply in the global market for labor, coupled with the falling costs and enhanced proficiency of machines, spells trouble for workers in any country who seem overpaid on the world scale.

Brazilians earned about $13,528 per employed worker in 2013 — 17 percent of the U.S. level of $79,622. Given this disparity, might Brazilian workers be more insulated from pressures beating down upon private laborers here?

In certain industries, perhaps. Brazilian workers enjoy a measure of protection; however, Chinese workers earned $4,428 each and Indian workers earned $2,119 each.

Investors must weigh whether they have confidence that local incomes will grow and allow businesses to increase their revenue, profits and cash flow. They also must decide how much scope Brazil has to lower local interest rates without destroying the value of its currency, measured against key trading and investment partners.

In theory, Brazil may have room to follow other countries and lower benchmark interest rates — during 2013, Brazil’s central bank discount rate was 10 percent compared with underlying consumer price inflation of 6.2 percent. In the United States, our central bank discount rate was 0.5 percent compared with inflation of 1.5 percent.

But now consider the local political climate.

Even by Brazilian standards, scandals swirling around recently re-elected President Dilma Rousseff threaten her credibility and her ability to lead the country, just as Petrobras, the state oil company, evaluates its capital-intensive energy development programs in the face of plummeting prices for petroleum and natural gas.

As with President Obama, Ms. Rousseff will soon have to face revelations from numerous scandals that seem to spread whenever political cronies become intertwined with large businesses that must navigate local regulation.

Given geopolitical instability, acrimonious national politics and vexing structural headwinds facing Brazil’s highly paid workers in the global economy, it is more likely that patient investors will find better places to commit capital to equity markets generally and to the Brazilian market specifically later this year.

Charles Ortel serves as managing director of Newport Value Partners (NewportValue.com), which provides economic research to executives and to investment firms.

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