Investing in Brazil: Why the Time is Right for This Out of Favor Market

by Carl Delfeld

Like everything in life, stock markets move in cycles. And nowhere is this clearer than with emerging and frontier markets.

It seems that investors either love them or hate them based on a cocktail of recent market performance, economic headlines and financial media hype.

Brazil is a wonderful case in point. Not long ago, it was the hottest market on the planet. From 2004 to 2008, Brazil’s stock market was up a staggering 350% while the S&P 500 was up 40%. Economic growth was around 8%, its currency was soaring, commodity prices were on a roll, and foreign capital was clamoring to get into the country.

But then, as so oftentimes is the case, Brazilian policymakers got a little cocky and started to mess up markets and the momentum.

Interest rates were hiked until they topped 12.5%, with consumer rates much higher. It slapped capital controls on foreign capital inflows. And perhaps, most damaging, it expanded its interference in Brazil’s two top heavyweights, Petrobras (NYSE: PBR) and Vale (NYSE: VALE).

Petrobras shareholders were sharply diluted by a mispriced government deal that traded energy reserves for shares. This sent Petrobras shares on a downward spiral and, since 2008, they’re down 50% while the overall market is down 20%. For Vale, the president pressured the then-CEO to resign because he didn’t make decisions based on domestic politics. Vale stock is down 60% from its 2008 high.

Brazil’s economic growth nosedived from 8% in 2008 to the anemic 1.5% growth projected for all of 2012. The Brazilian real lost value after a long run. The economy grew only 0.4% in the second quarter compared to the earlier three months.

Clearly the heavy-handed tactics of the government soured investors on the Brazil story. This is your opportunity, since the best time to invest in an emerging market is when it’s out of favor.

My advice is to “skim the cream,” meaning investing in a few of Brazil’s highest-quality, conservative companies.

Ride the Brazil U-Turn to Profits

I made a move on out-of-favor Brazil early this year with a blue-chip water utility company - SABESP (NYSE: SBS). It’s up 70%, beating the Emerging Markets Index by a 12 to 1 margin since I recommended it in The Oxford Club’s Communiqué. It’s up more than 15% since it was mentioned in Investment U Plus back in March.

Majority-owned by the state of Sao Paulo, SBS provides water and sewage services to over 25 million people in 365 of the 645 municipalities in the State of Sao Paulo. It has a stellar record over the past decade with an annual earnings-per-share (EPS) growth rate of just over 21%.

But there’s still time for you to get a piece of a Brazil turnaround by picking a couple of blue chips that are showing good momentum while still trading at bargain basement prices.

The policy debacles of the last few years have led to the policy pendulum beginning to shift again. Interest rates are moving downward, and payroll taxes and energy costs are also headed lower.

There are so many things that could be done to make Brazil more competitive. The slowdown has made it clear that something has to be done about the high cost of production, high import tariffs and high taxes.

The Economist points out a startling point. It’s cheaper for automakers like Nissan to import steel from South Korea made with Brazilian iron ore than to buy locally produced steel.

Brazil’s president, Dilma Rousseff, announced last month that the government is cutting electricity tariffs by reducing some taxes (right now 28 taxes account for 50% of electricity bills!).

My hope is that this welcome move is just the tip of the iceberg.

Good Investing,


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