Stay the course. Change the course.
February 07, 2014

Untitled Document

A month ago, on my first newsletter of 2014, I sustained that the best investment opportunity nowadays is the stock market in the USA. I claimed that, apart from the fact that I don’t know what will happen for certain, as long as the economic fundamentals of the economy are good, 2014 could offer a return on investments between 8%-10%. Since then, the market behavior seemed to prove me wrong: in January the S&P declined 3% and February started with the Dow Jones shaving 300 points. Well, I am still optimistic. Why?

The American economy continues to grow. It is true that economic data was not very positive lately but I believe that the weather might be responsible for part of those results.  Yes, the weather. The northeast and Midwest are having a winter to remember, one that had not happened in the last 10 years with  consecutive  snow storms and temperatures below freezing for weeks. The Chicago airport closed for the first time in history not because of the storm but because the cold temperature was posing a threat to the engines by way of congealing the engines; thousands of flights had been cancelled since December. The price of the residential propane gas increased 80% and there is a shortage due to transportation problems: there aren’t enough trucks or drivers to deliver the product.

As I write, 219 S&P 500 members, representing 58% of the index’s total market capitalization have reported results.  Total earnings for these 219 companies are up +12.0% from the same period last year, with 70.8% beating earnings expectations. Total revenues for these companies grew 1.8%, with more that 50% beating revenue estimates. The ISM for manufacture, published on February 3rd, came below estimates, 51.3% versus 56.5%. On the other hand, on Wednesday, the ADP index for private employment came in line with expectations and more important, the ISM for services came at 54.0 versus 53.0 in January. As we all know, the service sector is more important for the US economy than the manufacture service.

So, I believe the fundamentals are still good. How do I reconcile this view with the recent drop in the stock market? Firstly, I remember the difference between short and long term. I also remember that although we didn’t see much of that in 2013, there is volatility and there is profit taking. We might be going through a correction, maybe we will test low levels with the S&P going as far down as 1700; I don’t know. What I know is that we are still in a bull market and this might be a healthy and necessary correction before we reach new highs. So, I will just stay the course…..

One could argue that I am ignoring the problems in the emerging markets and in China. I am in fact and purposely. I agree with the analysts when they say that the developed economies “feast” with the weakening of the emerging markets via commodity prices and currency declines .To keep things in perspective not even Brazil was affected by the Argentinean crisis. Who could imagine such thing 20 years ago? China is a little different and the problem might not be only slow growth and slow demand.

The “shadow “banking system, although not as big as in the developed economies, is growing and it totally unsupervised. The companies without access to financing in the regular banking system have to pay a very high rate which poses a big liquidity crisis to the Chinese financial system.

I believe the problem of the emerging economies will stay in the emerging economies. Again, it is good to put everything in perspective: large part of the growth in the emerging markets in the last decade was propelled by the Chinese economy growth and the increase in international liquidity, due to the monetary policy of the central banks in the developed countries. Both the slowdown in China and the changes in the monetary policy in the USA are being broadcasted for a while. So, it should not come as a surprise to anybody, mainly to the governments in the emerging markets. This is the new normal for the emerging countries and Brazil: a world with less liquidity, with investors going back to safe havens and with China growing less.  In this scenario and given the fact that we did not use the good times to make the necessary reforms, we have to get used to lower growth rates: or we can go on a spending spree, always a tempting proposal mainly on an election year.

I believe that the pessimism in Brazil and the excess of bad articles about the country, do not express the real situation in Brazil. There is no indication of crisis, there are problems and there are solutions. It seems to me that the main issue is for the government to recognize that there is a problem. The best way to start is for the current administration to change its political attitude, stop being interventionist and recuperate business confidence: change the course.

I will end with two graphs, because they are worth 1000 words. The first compares the American stock market and the Brazilian stock market and show the different trend on both. The blue line is for the American stock market and the black for the Brazilian stock market. The second shows the market price of the Petrobras ADR; as we know Petrobras is controlled by the government and weighs almost 12% in the Ibovespa. Its price evolution is a result of the decisions made by the administration as its main shareholders. Looking at the graph and learning from it could be the first step for the Government to rethink the relationship between credibility, market rules and economic growth.

Brazil US Stock Market


3 Year Chart

  Petrobras ADR


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