Brazil as an Emerging Market - more than Caipirinha, Football and Samba?
Hello folks,
today we will talk about Brazil and its chances and perspectives for us investors from my point of view. Somewhat surprisingly, this topic won out over another nightclub topic and various individual stock analyses. Since the topic has met with such a broad response, I will therefore focus on Brazil. Beforehand, as always, my disclaimer.
DisclaimerThis is not investment advice. It is also not an invitation to buy or sell financial products. I am merely expressing my opinion here. You have your own responsibility towards your investments. Therefore no liability.
For the structuring of this analysis I take the following structuring:
Brazil as an Emerging Market in Facts, Figures and Figures 1.1 Introduction: Why is Brazil relevant?
1.2 What is the performance of Brazil isolated in the stock market?
2.Personal opinion to the recognized investment options and criticism
Brazil as an emerging market in numbers, data and facts 1.1 Why is Brazil relevant?
Many of you will know Brazil as the land of Samba with beautiful costumed women and men exuberantly celebrating carnival with live circuits from many local countries. In addition to the exuberant atmosphere, there are also great original Brazilian drinks such as the Caipirinha, which has long been world famous and brings with it a feeling of southern refreshing flair. From then on, I won't have to tell you what Brazil is and all is well.
If you haven't seen my latest video yet, you can find it here:
Hope you enjoyed the post and....
No - unfortunately we do not dance here until 4 o'clock at night drunk Samba and enjoy the beautiful sun. Because Brazil also knows severe poverty, crime, daily shootings and other socio-economic problems as an emerging country. But what is an emerging market anyway and why should we care?
Essentially, emerging markets such as Brazil, China and India have no common definition of what an emerging market really is and what you can pin it down to. If one does a platitudinous research on "emerging market definition," it becomes clear relatively quickly that all of the purported definitions can only loosely add up characteristics, but are generally incapable of providing a unified definition of "emerging market." (1) and (2) exemplarily point to an interplay of modern industrialized country claims - but at the same time emphasize that essential standards are not met in these countries or that their infrastructure is lacking. But what are these characteristics in concrete terms? Essentially (see (1), (2):
- Life expectancy is lower on average than in industrialized countries.
- Born children have a higher risk of stillbirth
- The level of education is generally lower and there is a general lack of universal access.
- Energy and water supplies are more likely to be in need of expansion
- GDP per capita is limited in its informational value due to high standard deviation and uneven distribution.
Thus, we see that Brazil, as an emerging market, is measured by the standards of the industrialized countries, but cannot meet them. In the end, moreover, there is not even the fixed possibility to translate "emerging market" with "emerging country". Often our understanding of emerging markets is shaped by the idea that we are dealing with "upstarts" from a smaller league of developed countries. In the English-speaking world, this conceptualization of emerging market tends toward "we group together all non-industrialized countries that meet certain standards and are not a frontier market or the like." Thus, the understanding of league membership in the respective cultural spaces is different. Our definition of emerging markets and frontier markets in English-speaking countries would rather be "upper-middle-income economics," which after all includes 55 emerging markets and leaves out frontier markets. The "Emerging and Developing Countries" partly include Frontier Markets according to our understanding and add up to 150 countries (cf. ibid.).
Frontier what?
Frontier markets are quasi comparable to the 3rd league in the Bundesliga system. They are countries in which it is possible to invest, but which are far less equitable, are subject to greater political risk than emerging markets, and are therefore unstable and/or subject to strong exchange rate fluctuations. In addition, there is information uncertainty and it is impossible to see if the data has been collected a) completely, b) credibly, or c) reliably. Good for us at this point: Brazil is considered an emerging market and tends not to have these problems (see (3)).
Why is Brazil important?
With a gross domestic product of 1.61 trillion U.S. dollars, the 5th largest per capita income at 6,527 euros among emerging markets, and thus an above-average performance within emerging markets at only 5,881€, it can be seen that Brazil is relatively advanced in its development. Only China, Malaysia, Turkey and Mexico achieve greater values in per capita income. It should be noted here that China, as the main performer in the tech industry, Turkey, as an EU accession candidate, and Mexico, as a very important economic partner for the industrialized country USA per se, have certain advantages over Brazil. Nevertheless, Brazil's economic performance is well worth a closer look. Measured by the HAI, i.e. the Human Assets Index, Brazil also achieves second place and is only eclipsed by Turkey, which scores 97.1 points, just 1.2 points higher (see (1), (4), (5)).
What does this mean?
Essentially, the HAI indicates how well the individual citizen is provided for. It is virtually a parameter for how far the respective emerging market is from being "relegated" to the league of "frontier markets". The higher the index value, the better the literacy rate, access to the healthcare system, nutrition and the lower the risk of losing a child at birth. Taken together, these parameters give Brazil a score of 95.9 points, indicating that within this individual framework Brazil can obviously offer a more upscale standard among emerging markets (cf. ibid., (6)).
But I saw this documentary on the favelas, where....
Yes - but we are not talking about our standard here, but a parameter that sets lower standards. Within this quasi "not perfect" supply below industrialized country level, Brazil performs relatively well according to current data. A look at (5) already underpins the enormous growth of up to USD 2,6104.03 billion in 2021 and...
This is not true. Because the figure on the GDP of Brazil is correct, but not the year. Specifically, it is 2011 and not 2021, which is very important in that the GDP curve from 2011 resembles a V and reached its minimum USD 1,448.55 billion in 2020 at Corona times. But even before Corona, Brazil's GDP was falling consistently, which was particularly negative in 2015-2016. Brazil, as an emerging market, has been and continues to be heavily dependent on foreign financing to fuel its economic growth. In simple terms, loans are intended to provide the monetary basis for companies to grow. Loans incur interest payments, which in turn can increase the burden. It's a familiar situation, especially in the current context: the house is fully financed at 110%, then a massive interest rate turnaround catches you by surprise, and then you have no idea how you're going to manage the follow-up financing. Brazil had a similar problem in 2015: Because a swelling accusation of corruption around leading politicians as well as the then President Rousseff did not want to subside, Brazil lost the confidence of investors, so that the Brazilian government bonds were downgraded several times. In the end, Brazilian government bonds were at the BB+ level at the worst time (see (7), (8)).
That doesn't sound so bad, does it? What do they have? B is 2, isn't it?
That's the problem: BB+ and BBB- are separated by only one notch - but while BBB- requires an average credit score, the BB+ rating doesn't need it. So it tends to be easier to achieve this credit level, which can also have an impact on lending. So this is not niche fishing knowledge, but has become a huge problem for Brazil - the worse the credit rank, the more interest has to be paid for the potential risk of default (cf. ibid.).
So they pay €2.50 more, so what?
A country that has an inflation of about 10%, can sell its raw materials for less revenue on the world market and generally less to encourage people to consume domestic goods, pays these 2.50 € not just like that. Moreover, as a combination of this with the little trust in political solution finding due to corruption, the GDP falls. The result is a vicious circle that threatens Brazil's status as a major South American emerging market. So we note: Brazil needs credit to finance its economic strength and fell out of favor with investors due to the circumstances described above. But is growth the only reason for this borrowing (see ibid, (9))?
No - because Brazil was already struggling with an enormous debt burden in 2002, at $250 billion. By way of comparison, Germany's debt ranged from €1,211 billion to around €1,490 billion between 2000 and 2005 (cf. (9), (10)).
Is Brazil not king then, since it has less debt?
No. The mere amount of debt says nothing about the ability to refinance it. To put it simply: If I am a millionaire and have debts of €10,000, my starting position is different from if I were a truck driver at subsistence level. The comparison is now relatively nasty and I am aware of that. But if I have or earn a regular income that is above my debts, I personally consider that less dangerous than the opposite. In the case of Germany, that means the higher debt was equivalent to 59.7% of GDP, which was about the same as France at 60.3%. Brazil was at about 79%. Currently, Germany's debt is 2.34 trillion euros, while France's is 2.9 trillion euros. But where does Brazil currently stand (see (11), (12), (13))?
At approx. 88,19%
national debt as a percentage of GDP. This shows that Brazil is a heavily debt-ridden country that covers most of its refinancing through the capital market. Although the future is currently viewed positively, the long-term trend is upward. In other words, Brazilian public debt is expected to rise to 93.25 % by 2027 (see ibid., (14)). Nevertheless, Brazil is very self-confident internationally and demands participation in a wide range of decisions and in dealings with the United States in particular (see (9)).
What does this mean in context?
As a quintessence, I list the following points for myself (cf. ibid.):
- Brazil's GDP is currently rising again, but fell massively in the 2010s
- Confidence in political stability was already the main reason for recession
- Brazil will not be able to perform on the world market without loans, even in the long term.
- Brazil's debt burden potentially limits growth in a rising interest rate environment.
- Refinancability is directly and significantly linked to the interest rate environment.
- There are individual disagreements with the USA, among others.
These points should guide us for the time being in taking a closer look at Brazil as an investment case. With this basic understanding it should become clear why certain events influence the category of emerging markets and how.
2) What is Brazil's performance on the stock market in isolation?
As many of you know I am a big fan of making valuations of stocks, ETFs. Etc. So now let's take a look at what Brazil is showing specifically in terms of isolated ETFs in the stock market. I use (15) for this and get 7 ETFs offered after all. It is noticeable that only 5 of these ETFs have shown performance for 5 years. For further evaluation, I use the Brazil IBOVESPA (BI) Index and put it in relation to (see (15), (16), (17)):
1) MSCI World
2) MSCI Emerging Markets
3) ACWI
I would like to emphasize explicitly at this point that this does not represent any investment advice. According to (15) I use the current best performers. Personally, I do not use any of the products shown. In order not to advertise, I will therefore continue to speak only loosely of the MSCI World, for example. After all, it should only be an index comparison.
The Brazil IBOVESPA Index consists of 71 companies that account for 70% of the market capitalization of Brazil. More precisely: from the stock exchange in Sao Paolo. It is structured by market capitalization and is considered the gold standard for investments in Brazil. Well-known representatives are (cf. ibid.):
- Petrobras
- Itau Unibanco
- Banco Bradesco
- Vale
It is noticeable in the direct comparison that BI has outperformed all other indices in the period 2017 to 2022 and is at +57% appreciation since 2017. In 2nd place is MSCI World with about 24.55%, followed by ACWI with 17.54% and EM's negative return of -24.69%. Yes read correctly: The group that includes the strongest index in this comparison performs the worst. Why is that (see (18)). Essentially, this fact shows that EM is also largely influenced by other markets and countries. If we include the MSCI China Index, the performance is -42.61% (see ibid.).
So what?
These almost -43% were utilized in the emerging markets with a 47% share, taking February 2021 as an example. Thus, the EM are strongly coupled to the Chinese part of the EM and Brazil plays a minor role with 15.11%. Meanwhile in 2022, China is back at 26.89% and Brazil at 6.45%. So we can see that there is still a strong weighting of EM on countries other than Brazil (see (19), (20), (21)).
If we add the knowledge from 1.1, the question arises about the further future of Brazil - will this trend continue?
I do not have a crystal ball either - at this point I would like to refer to the MSCI Brazil in order to make a concrete country ETF comparable with the above mentioned indices. So now an outperformance should be seen also on ETF level. In the 3 year period, however, it shows that this MSCI Brazil has delivered only about -1% return, while the boring solution MSCI World brought in at 30.41%. Even the Emerging Market ETF has delivered just under 2% and was thus higher in terms of profit. Why is that (see (21), (22), (23), (24))?
If we compare the Ibovespa Index with the MSCI Brazil, the latter has performed much worse, returning only about -6.35% over the 5-year period, while the shiny index has returned just under 60%. The hammer still comes: Although this index only represents a partial mass and is relatively small, it shows the best performance in the index comparison with important sizes such as the S&P 500, the Nasdaq Composite, the Stoxx Europe 600 NR, the Nikkei 225 and the ASX 200 (see ibid.).
Really. At least as long as I leave the view at the 5 year cycle. If I reduce to 2 years, Brazil is no longer number one in the index comparison, but is beaten by the Stoxx Europe. So Brazil is an exciting driver of world economic growth.
However, there are probably a lot of questions for you now:
- Why is the IBOVESPA index performing so strongly when the MSCI Brazil is doing so poorly?
- Where does Brazil get this immense potential for economic growth?
- The long-term trend is down via inverted V - how much power is there left?
- Why is Bass-T not invested in Brazil?
For all these questions, if you are interested, I will be happy to write a second part on Brazil.
Nevertheless, as a strong emerging markets critic, I enjoyed writing about this topic and I hope you enjoyed it. Now it's your turn:
- Do you want a second part?
- Are you invested in Brazil? Why/why not?
I appreciate your constructive feedback and remain with kind regards!
Your Bass-T
Sources:
(1) https://www.laenderdaten.info/schwellenlaender.php
(2) https://www.bmz.de/de/service/lexikon/schwellenland-14810
(3) https://www.investopedia.com/terms/f/frontier-market.asp
(4) https://www.grin.com/document/103105
(5) https://de.statista.com/statistik/daten/studie/19364/umfrage/bruttoinlandsprodukt-in-brasilien/
(6) https://www.enzyklo.de/Begriff/Human_Assets_Index
(7) https://www.n-tv.de/wirtschaft/Brasilien-verliert-an-Kraft-article17136326.html
(8) https://www.dw.com/de/fitch-senkt-brasilien-rating/a-18785952
(9) https://www.deutschlandfunk.de/brasilien-ein-schwellenland-will-grossmacht-werden-100.html
(15) https://www.justetf.com/de/how-to/invest-in-brazil.html
(16) https://de.finance.yahoo.com/quote/%5EBVSP/components?p=%5EBVSP
(17) https://www.finanzen.net/index/bovespa
(18) https://de.marketscreener.com/kurs/index/BRAZIL-IBOVESPA-7656/charts-comparison/
(19) https://capinside.com/c/emerging-markets-china-als-eigenstaendige-anlageklasse
(21) https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111
(22) https://de.marketscreener.com/kurs/index/BRAZIL-IBOVESPA-7656/charts-comparison/
(23) https://www.bmz.de/de/laender/brasilien
(24) https://de.marketscreener.com/kurs/index/BRAZIL-IBOVESPA-7656/charts-indexes/
