Newsletters
Looking back, looking forward
August 18, 2015

Untitled Document

We are constantly bombarded with news, newsletters, emails, and alerts, making it very hard to sort out what is relevant. We have to learn how to read the news, connect all the facts and ultimately make decisions based on the news.

To me the basic rule is: ignore the noise and focus on the fundamentals.

I took a look at my investment decisions and advice during the past 2 years to see the result of following that principle. So, I started looking back (the easier part): we had the worst crisis since the great depression and different countries and governments responded to the crisis in different ways leading them to different places.( see chart on my blog)

Brazil for instance, didn’t use the boom prior to the crisis to make necessary adjustments and invest in infrastructure. When the crisis came, the response, which I personally found was correct at the time, was to stimulate the economy via several fiscal and monetary instruments. However, at the same time, ignoring that the conditions had changed, the government insisted in the expansion of the social program and government expenses. Commodities never recovered and the country started to face increasing twin deficits and increasing inflation, which is where we are today. I believe in fiscal responsibility so when the government continued to act as if nothing had changed and continued to expand its social policies I became very pessimistic.

Let’s take a look at China: growth in China was driven by government policies and investments as well as exports. There was a huge investment in infrastructure - in construction. China was consuming all iron ore in the world and thus stimulating Australia, Brazil, South Africa and others. China has six of the top ports in the world and six of the top airports in the world. These investments were not driven by market conditions. One could point out that I am contradicting myself here because I just said Brazilian government did not invest in infrastructure. The problem is Brazil underinvested and China overinvested. The Chinese government invested way beyond what was driven/required by the real economy. That was unsustainable and now China has ghost towns and unused highways, airports and ports. Let’s look at the Chinese stock market: thinking that a climbing stock market was good for the government’s image, the government stimulated the stock market by making it easy for investors to buy stocks on borrowed money. However, these actions were unsustainable because the underlying economy had so many imbalances, and the stock market was destined for decline. So the government once again intervened, this time to stop the decline.

So, China today is a country with an overwhelming debt load, ghost towns and troubled real estate developments, and underutilized infrastructure. As I am very skeptical of a state-driven economy I stayed away from China thinking that its growth was unsustainable. As a result of the vision above, I advised against investing in both Brazil and China. Of course those who followed my advice missed the rallies and so did I. Do I regret it? No, because in the meantime I was suggesting investing according to the principles in which I believe: an economy driven by market forces, an economy that has a fantastic entrepreneurial class, a government that - against all the odds - passed an stimulus package very early in the game, a central bank that understood the magnitude of the crisis and started an easy monetary policy very early in the game. Most importantly, an economy that has flexibility to adjust. I am talking about the US, of course.

I have suggested to invest in American companies and also in US companies that could benefit from the boom in China and Brazil. So instead of taking the direct country risk I was betting on the stewardship, efficiency of the American companies with business abroad. Any person who believed in the above, could have just bought a general index - for instance the SPY(S&P 500 ETF) - and since 2009 would have earned 88.6%, almost two times the initial capital.

Before more talk about the US let’s look at Europe post crisis: what are the Europeans problems besides the basic fact that it had put together, under the same currency, a set of countries with different economic conditions? How could a project financed in Greece cost the same as one in France? It would lead to poor resource allocation and could not end well. Besides, there are all the regulations in Europe, the rigidity of the labor market and the social programs. When the crisis came, they decided to follow austerity and we can see where they are now. The ECB came in very late to do “whatever it takes” to stimulate the economy. The ECB quantitative easing was announced in January and had an immediate effect on the stock market as we can see below. In March, when it effectively started, there was another jump in the index. I missed that one, because I was not considering Europe. This one hurts a little more because, in the meantime, US stocks were not going anywhere. Fortunately, due the volatility in the past few months and thanks to China and the last economic indicators in Europe, there is still time to get in.


The short and long term: looking forward.

Although the American economy is still thriving, with unemployment and the deficit on the decline, one cannot ignore the headwinds. First, given the current state of the world, the first distinction an investor must make is between the companies geared toward the American market (not so dependent on growth in other economies and not so dependent on the dollar) and the companies that have a substantial part of their business abroad, and thus are more export dependent.

Second, there are interest rates. Does an increase in the interest rate means the end of the bull market? Not necessarily. What really ends the bull market is a recession. As for the interest rates, it will depend on the rhythm and magnitude of the increase. My take is that the FED is very aware of the world in which the US is positioned, aware of the impact of a strong dollar in its companies and money inflow, and aware of the impact of slower global growth on its economy. My view is that the economic conditions are not asking for an increase in interest rates, but on the other hand, it seems that the FED feels almost forced to raise interest rates. So it is possible that they resist the pressure and don’t raise rates at all in 2015, or if they do raise rates, that they make small increases spread over a long period. Unless of course the conditions change.

So the US economy is still doing well, but does that fact necessarily reflect in the stock market? Not really. Let’s take a look at the earnings so far. Up to now more than 88% of the S&P companies reported earnings and while almost 70% of those companies beat earnings, only 49% beat revenues - for that, you can blame the strong dollar and low world growth. That also explains the recent volatility- discounting China and Greece: every time a company lowers future guidance, the market jitters.

Looking forward, if you read my last newsletter you will realize I changed my view: I was skeptical about China, but now I fear that we have not seen the worst of it. I am afraid that the same applies to Brazil; we will have more bad news in the next couple of years. I was skeptical about Europe but after kicking the ball down the road once again in regards to Greece, maybe we have reason to become optimistic. Although 2015 has been tough for investors, just keep the long term view and hold on to good stocks. Also, take a Dramamine to bear roller coaster.

 

November 23, 2015
Much ado about nothing
October 27, 2015
Brazil, we can only pray (or hope)
June 30, 2015
Lack of good news
April 14, 2015
What if...
February 24, 2015
What to expect in 2015
November 17, 2014
The American conundrum or just plain stupidity?
October 27, 2014
What is next?
September 09, 2014
Lessons we should have learned
August 12, 2014
US and Brazil: 2014, what to expect next
June 26, 2014
Headwinds ahead but still optimistic
April 26, 2014
Roller Coaster
March 14, 2014
Brazil in perspective
February 07, 2014
Stay the course. Change the course.
January 17, 2014
Diversification. Or not.
November 25, 2013
Who buys a US$ 500 pillow?
October 02, 2013
Disturbing
September 03, 2013
What a mess...
July 31, 2013
Of Protests and Stocks
June 19, 2013
Betting in the future
April 30, 2013
Nowhere else to go
March 26, 2013
Cyprus: not enough to stop the US market
February 25, 2013
The Sequester
January 23, 2013
2013: what is ahead for investments
December 07, 2012
Brazil: uncertainty and mixed signals
November 05, 2012
It is not about the economy!
September 20, 2012
The Country is better off
July 05, 2012
The New Normal
May 30, 2012
Half empty, half full
April 30, 2012
How to restore prosperity
April 21, 2012
Brazil became poorer
February 27, 2012
Romney, Obama and the American Imbroglio
January 25, 2012
On storms and calmness, waiting for next round
December 22, 2011
Happy Holidays!
November 23, 2011
Impasse and Paralysis
October 24, 2011
The rally has legs. Or not
September 23, 2011
Preparing for the crisis
August 24, 2011
Kicking the can down the road: is there an end in sight?
July 24, 2011
Can the politicians be rational?
June 24, 2011
Global Economy: where are the world leaders bringing us?