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US and Brazil: 2014, what to expect next
August 12, 2014

Untitled Document

When I was a mere spectator of the stock market I used to be shaken by the rapid swings in prices and I used to believe in the headlines and the explanations given by the media: today the market is up because the ISM came up strong, or today it’s going down because of the Iraq invasion or because a plane has crashed. Truth is that, most of the time there is a set of negative and positive news and each person can use whatever is convenient to explain the swings, in any direction. In the past weeks there was no lack of news- bad news- to cause volatility, from the tensions in Russia to the Argentinean default.

The fact of the matter is that the daily swings are unavoidable and the retail and small investor can’t do anything about it. The presence of big institutions and the HFT make it very difficult. It is also very true that at the end of the day, reason, logic, planning and research should prevail and be the main determinants of investment decisions.

I still believe in stocks as a better investment compared to bonds or real estate. For someone who doesn’t have capital to start a business, investing in stocks is a way to participate in the economic growth, in the innovation, and one can be a winner regardless of the market direction. Hindsight is easy but I have on my side the fact that anyone can go back and read my old newsletters and find out how long I have been positive and optimistic about the American stocks and how long I have been pessimistic about the Brazilian market.

There is a reason for such a different approach. The American economy was recovering, gradually, and despite the skepticism and critics, despite a dysfunctional Congress and the battles between Democrats and Republicans. The ideological war overshadowed the narrative about the recovery, and I, amongst others, was fortunate to isolate the noise and see the big picture, so I wanted to be part of that recovery and that meant investing in the stock market. I didn’t want to be a part of what I was seeing in Brazil. When president Dilma took office there was optimism and confidence; the market believed that she was going to show the same pragmatism showed by Lula. After a little while the difference between both became clear; Lula was helped by a favorable external environment, which disappeared in Dilma’s first term. Adverse conditions plus interventionist policy was not a good combination and led to low growth and almost destroyed Petrobras and the utilities sector. I didn’t want to participate, as a small investor, in that economy. For what it’s worth it must be said that the government started to change course in the last six month with the Central Bank actions in the monetary policy, and the start of some infrastructure projects.

Enough said about the past. What do I still expect for 2014? I still believe that the minimum gain in the stock market will be around 8%-10% in the USA, I believe we will only see an increase in interest rates in mid-2015, I don’t believe we are in a bubble. We are probably getting near the top of a cycle which asks for caution. So I am cautiously optimistic.

The earnings season was the best in the last few years with a growth of 9% in the second quarter earnings (as opposed to 1.1% in the first quarter). Revenue grew 4.6%, as oppose to 2.7% on average in the last four quarters. The labor market is stronger and has been growing for 7 consecutive months. The numbers of the American economy are solid, despite the volatility and nervousness of the agents, despite the fact that the fear of an asset bubble is growing.

The apprehension comes not only from the external front and from geo-political instability, but also from the fact that stocks are at all-time highs. So is real estate. In New York the new normal is to see 700 square foot apartments in the new developments with a listing price of 1, 5 million dollars. As per the stock market, despite the high prices they are not overvalued as it was the case in past bubbles. Also, the recovery in Europe and japan will have a positive effect in the USA.

What is puzzling for me is that notwithstanding the good news on the economic front, Americans are unhappy with the economy and the government. It is true that the prosperity didn’t spread to all areas and all income classes. Unfortunately there are still way too many Americans out of the labor force, having difficulty making ends meet as the wage and income recovery are still in the beginning. Obama is showing the lowest numbers in popularity and there is a midterm election approaching. It is too bad that that the improvement in the labor market and wages is delayed and its benefits might appear after the elections.

Brazil, on the other hand, is completely different. I still believe that Dilma will be reelected, which means there will be no big changes in economic policy. The Brazilian stock market is performing better in 2014, after having underperformed the S&P by almost 70% in the past years. The hope of change is driving some of the performance: each time Dilma loses a point in the polls, the stock market gains several points. The Real is being supported by the Central Bank and we are in fact in a controlled exchange rate system. The labor market is still solid, although it’s starting to crack and that still gives a good feeling. That and the amount of social programs in place can probably guarantee a win for the government.

As a result of what I am seeing, I don’t believe that the stock market recovery in Brazil will last and I believe the Real will depreciate further. Of course that will change if the opposition wins the election. How different?  Initially, confidence will be restored and probably the stock market would rally. As per the exchange rate, things are not so simple. The new government doesn’t need only a confidence boost - that only buys some time. The new government needs to show very quickly a change in economic policy and that will probably mean a weaker Real. In any scenario, with any victor, I don’t believe 2015 will see economic growth. Unfortunately, changes in economic policy take a while to get to the real economy.

 

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What if...
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What to expect in 2015
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What is next?
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Lessons we should have learned
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Headwinds ahead but still optimistic
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Roller Coaster
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Brazil in perspective
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Stay the course. Change the course.
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What a mess...
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Of Protests and Stocks
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Betting in the future
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Nowhere else to go
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The Sequester
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2013: what is ahead for investments
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The New Normal
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How to restore prosperity
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