Complexity behind Brazil’s recovery

There was a time not long ago when Brazil’s capital markets were driven almost entirely by global macroeconomic conditions – witness the panic sell-offs sparked by the Asian and Russian crises of the late 1990s.

So for many investors the relative ease with which Brazil sailed through the latest global crisis has been cause for relief tinged with incredulity. But Brazil’s shallow recession and rapid recovery do not mean it has decoupled from the outside world, just that things are more complex.

Investors have had to wrestle with conflicting drivers: the power of Brazil’s fast-growing domestic market and, conversely, the extent to which some companies’ fortunes are dictated by external forces. “A lot of people are focused on private companies that are masters of their own destiny,” says Frederick Searby, Latin American equity strategist at Deutsche Bank in New York.
“Vale [the world’s biggest iron ore miner] is like a warrant on China. But companies like Natura [cosmetics] and AmBev [brewing] are domestically orientated and can buck the trend.”

It has therefore been a mixed year for Brazilian equities. Foreign investors account for one-third of daily trading volume in São Paulo and buy two-thirds of most share issues. External flows have switched direction with investors’ mood swings over, for example, the European sovereign debt crisis and the risk of a double-dip recession.
Brazil’s main stock index, the Ibovespa, had fallen 4.9 per cent this year by Friday’s close. But it had gained 23.8 per cent from its low point on May 20.

Nick Robinson, senior investment manager at Aberdeen Asset Managers in São Paulo, says the outlook is “generally fairly positive”, but investors will be watching the build-up to October’s presidential and general elections.

“You know that with Dilma [Rousseff, the leftwing government candidate] the housing sector will be safe because she put together Minha Casa Minha Vida [a subsidised mortgage programme]. But you’d be more worried about private companies that have a natural monopoly, such as BM&FBovespa [the stock and futures exchange].”
He says uncertainty over government plans for Petrobras, the national oil company, including a proposed share issue estimated at $25bn that is expected as early as next month, means that many institutional investors have allowed its recent underperformance to reduce its weight in their portfolios. He expects them to take advantage of the share issue to correct that.

Analysts are optimistic, too, about Brazil’s debt markets, where there will be no shortage of investment opportunities. Huge sums will be spent preparing the country to host the 2014 World Cup and 2016 Olympic Games. Investment in potentially enormous offshore oil fields discovered in 2007 will follow.

“There will be a lot of investment and a lot of capital will be required to fund it,” says Filippe Goossens, a senior analyst at Moody’s Investors Service, the rating agency, in New York. He says many Brazilian companies have gone public since 2004 and later returned to the market with follow-on issues.

“The logical next step is to tap the debt market, because the more equity you issue the more existing shareholders are diluted, and debt is cheaper than equity. So this bodes well for new issuance in the fixed-income market.”

This is already happening. Brazilian companies have issued about $15bn in overseas bonds this year. This is in addition to about $4bn from the government. Foreign issuance should easily overtake last year’s $25bn – itself a rebound from $6.6bn in 2008.

Domestic issuance is also going strong, although the Brazilian convention of holding very short-term debt until maturity means a viable secondary market has yet to develop.

João de Biase, head of debt capital markets at Itaú BBA in São Paulo, says this could change quickly, in the next two to three years. This is because more investors are expected to turn to corporate debt as Brazil’s high interest rates continue to fall. Investors are also taking an interest in eurobonds from Brazilian issuers, he says. “There are very few stories like Brazil that have that volume and diversity.”
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