Brazil’s gamble on global financial meltdown

Brazil is gambling that the global economy will worsen – if it gets its bet wrong, investors will suffer.

The Brazilian central bank has been taking the machado to its base interest rate, first surprising markets with a bumper 100 basis point cut at the end of August, and then last night swiping off another 50 basis points to 11.5%.

By embarking on this strategy, the authorities are stating quite clearly that rising inflation, which hit 7.3% last month, is not their priority. Instead, it’s the threat to economic growth that they’re worried about – one that hinges on unpredictable developments in Europe, China and elsewhere.

This is a ‘high risk’ strategy, explained Sebastian Luparia, who manages JP Morgan’s Brazil investment trust. ‘The government is very concerned about external markets. That’s why it's making a bet and trying to be pro-active,’ the investor said from his Sao Paulo base. ‘The right decision is to be proactive and cut rates. But the magnitude is too much.’

Economists at HSBC say the central bank has been responding to an adverse scenario that has yet to materialise.

Skittish investors seem to share this growing unease. The latest data from EPFR shows that in the second week of October Brazil equity funds posted their biggest outflows since March. And according to a survey of fund managers from Bank of America Merrill Lynch, enthusiasm for Brazil has waned, though investors do remain overweight there.

Brazil depends less on exports than other emerging markets. But the goods it does shift overseas mainly go to China. ‘So whatever happens in China will have impact in Brazil and whatever happens in China is linked to the global economy,’ said Luparia.

Not everyone is down on the central bank. Some say that it has moved presciently. ‘Brazil is often among the first economies to be hit by a deterioration in global conditions’, commented Neil Shearing of Capital Economics, and recent data already suggests this is happening, he added.

But this uncertainty does not make it easy for investors in the region. One of the top investors in Brazil, Will Landers, who runs the BlackRock Latin American investment trust, reported yesterday that shares in his trust dropped 14.3% in September, even worse than the 13.7% decline of the broader Latin America index that it benchmarks. His fund, which features in Citywire Selection, is heavily exposed to Brazil. And Alan Saunders, chairman of the JPMorgan Emerging Markets Investment Trust, admitted in the trust's annual report this month that high prices, a strong currency – which has been the subject of extreme volatility – and a lack of liberalisation means ‘Brazil has been a relatively difficult place to make money,’ a sentiment that Luparia agrees with.

The Brazilian stock market, the Bovespa, has lost some 22% of its value so far this year, worse than the broader emerging market index. And the volatility in the commodity-heavy index will undoubtedly continue. Luparia has responded by shifting his portfolio further away from companies that are closely tied to the economy.

He says the market is now good value. ‘There are lots of uncertainties. When there are some certainties, there will be multiple opportunities to benefit. But the timeframe is very uncertain,’ according to Luparia.