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The Sequester
February 25, 2013

Untitled Document

The second week of February was intense: the Pope resigned – an act without any precedent in history – the President presented the State of the Union, Comcast acquired the remaining NBC shares belonging to GE, Berkshire Hathaway and the Brazilian group 3G acquired Heinz, and American Airlines merged with US Airways. In the meantime, Brazil was celebrating Carnival and as always, the country paused. The Brazilians who don’t like samba were on the beach, skiing in Aspen or shopping in New York. During the same week, a ten-ton meteor streaked through the sky in Russia, another very rare event.

Obama’s speech didn’t mention anything new; it was a repeat of the inaugural speech, discussing immigration, gun control, climate change and the like. Obama wants to raise the minimum wage from $7.25 an hour to $9.00 an hour nationwide by 2015. He also wants to link the increase of the minimum wage to the cost of living, a disastrous mechanism that in Brazil is called “indexação,” and which brought the Brazilian economy to hyperinflation. After the speech, Obama made a call to thousands of supporters and asked again for their help to push Congress to vote in the various themes. As I’ve pointed out in the last newsletters, this is Obama’s new tactic: bring the fight to the voters, to the street, and blame the republicans for whatever is not done.

The House, so far, is ignoring the need for action in several themes. Since the beginning of the year, they haven’t voted on anything, except for the Sandy relief legislation. Even worst, from February 15th to 25th, the House is in recess, meaning that they will be back to work just a couple of days before the deadline for the “sequester”. The debate about the upcoming budget cuts is again sold as a choice between cutting programs for the less privileged versus greater taxes for the wealthy. Democrats side with the middle class and want more taxes, republicans side with the rich and don’t want to see any revenue increase. The truth is that the 85 billion dollars of cuts on the course of 2013 represents only 0,05% of the GDP. In the dramatic narrative of the democrats, thousands will lose their jobs, airport security will be compromised, teachers will be laid off and so on and so forth. The Tea Party seems determined to allow the sequester to happen and are adamant about it. Although it is not that big and will occur over the course of the year, the American economy doesn’t need that; not only is the fiscal situation not in danger but also the economy is still recovering very slowly - if anything, it would be time for the Government to spend more, not less. A more important and big battle will occur by the end of March, when the Congress must pass a resolution to continue funding Government operations.

The stock market continued in its trajectory to reach new peaks and it seemed that nothing could alter that path. The earnings season has been better than expected; the economic data was mixed but good most of the time. Although the problems in Washington were/are the center of conversations, it doesn’t seem to bother investors. Those who were waiting for a pull back to get into stocks had their opportunity on the 20th when the minutes from the last Fed meeting were released. It is worthy to point that there was nothing new there. There have been dissonant voices inside the FED for a while. Moreover it is difficult to believe that   there could be an increase on interest rate in 2013 or even 2014 with an economy still fragile and constantly threatened by crisis made in Washington.

This being said, I believe that notwithstanding the pull back, which some could see as an opportunity, the tendency is still bullish for the USA stock market. The American companies are in a very good situation: they have lots of cash, low debt and at a very low cost. The so-called high yield bonds are not offering more than 5% per year. It is not difficult to understand why the stock market is still the best game.

In Brazil however, the situation is different. If in the United States the Government is not active, in Brazil it is super active: a report from Barclays compiled the 42 measures that the Brazilian Government implemented in the last 2 years in order to stimulate growth and control inflation. The Government is also supposed to announce this week another measure to provide public funds for infrastructure projects. The Brazilian investor that until recently had the comfort of the fixed income investment is now without options: until the 20th, the Bovespa had a loss of 7.83% and 15.14 year/year.

Brazil retail sales showed retraction in December, for the first time since last May. Albeit all price controls imposed by the Government, it seems that the consumer is backing off.  Over the last few weeks the Central Bank admitted the possibility of an increase on interest rates. The least we can say is that the scenario is very confusing. Last week former President Lula floated Dilma’s name for reelection. Dilma would like to run on the decline of interest rates and the increase on social inclusions recently showed by the expansion on the Bolsa Familia program. Will the Central bank have political room to increase interest rates? Trombini insists that inflation is the priority. Make your bets.

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