Economic growth, which had been humming along at over 4% a year, slowed to an annual pace of just 1.9% this year and is expected to grow an anemic 2% in 2015. That would be terrific for a mature economy like Germany but lousy for a large developing economy like Brazil. No wonder Standard & Poor’s recently lowered the country’s sovereign debt credit to BBB-, the lowest investment-grade ranking.
The collapse of the commodity super cycle hit Brazil hard. It turned out that much of Brazil’s economic success had more to do with the commodities boom than genuine structural reforms. Brazil had always been a major exporter of commodities. But with China’s appetite for commodities cooling, the wind was taken out of the sails of the Brazilian economy. And the advent of fracking has made Brazil’s discoveries of large offshore oil reserves less relevant. Not that Brazil’s dependence on commodities was a surprise. Back in 2010, Harvard economist Ricardo Hausmann had attributed 80% of Brazil’s improvement to high commodity prices spurred by high global (read: Chinese) growth.
The structural problems weighing on Brazil’s economy, which were easy to ignore during the commodities boom, were never addressed. Notably, Brazil today devotes only around a fifth of its national income to investment, compared to 25% for the average emerging market. Taxes are too high. Corruption, regulation and bureaucratic red tape are a millstone around the neck of the economy.
The government continues to play too large a role in the economy. On the one hand, the Brazilian government is pouring billions of dollars into upgrading its roads, railways and airports. On the other, Brazil’s track record of implementing public investment programs is astonishingly bad.
The current World Cup offers a perfect example. The original budget for the World Cup was $1 billion. That ballooned to $11.5 billion — an almost 12-fold increase. The U.S. soccer team won its game against Ghana yesterday in a government-built, $270-million stadium. Only four World Cup games will ever be played there. That’s $67.5 million a game for a stadium that will never again see more than 10,000 fans.
Why You Should Invest in Brazil
Now you might think that based on what I’ve written so far, I’d recommend that you stay away from investing in Brazil.
But you would be wrong.
I actually think Brazil could turn out to be one of the world’s top-performing stock markets over the next 12 months.
First, early polls show that presidential elections in October may give current President Rousseff the boot. Any change of government could be just the ticket to get Brazil’s economy back on track. The prospect of market-friendly economic reforms in India, after last month’s election of Prime Minister Modi, has turned India into the #1 stock market in the world. The same thing could happen easily in Brazil, as it did back in 2002.
Second, the Brazilian stock market is trading on a cyclically adjusted price-to-earnings (CAPE) ratio of 10.2, making it one of the world’s cheapest major stock markets. That means there is plenty of upside for investors willing to take the plunge.
There are a handful of ways to take advantage of any upswing in the market. The iShares MSCI Brazil Capped (EWZ) is a good place to start.
In case you missed it, I encourage you to read my e-letter column from last week about why you should never short a dull market.
Nicholas Vardy is currently editor of the monthly investment newsletter, The Alpha Investor Letter, which provides longer-term global investments. He also writes two weekly trading services, Triple Digit Trader and Bull Market Alert, which focus on making short-term profits in the hottest markets in the world.