03 Mar 2010 | World

Global Economy - A Sporting Chance for Brazilian Prospects 

Brazil has been awarded the 2014 football World Cup and the 2016 Olympic Games. These events will be important for Brazil and will create a need for infrastructure and development projects, which will generate attractive investment prospects for investors.   

Brazil has had a long history of booms, busts and false dawns, with periods of economic strength, over-borrowing by governments, corruption scandals, political crises and inflation.

The country is currently enjoying another upward cycle. This time it is being driven partly by commodities and, more importantly, by a rapidly emerging base of domestic consumers. Other factors include the wide-ranging economic reforms implemented by President Fernando Cardoso who was in power from 1995 to 2003. These involved opening up the economy, privatising many companies and modernising the federal bureaucracy and government banks.

Although many people expected him to reverse some of the changes, Cardoso’s successor, President Lula moderated his policies and left the reforms intact. Together with a well-regulated banking system and large currency reserves, this has enabled Brazil to come through the economic crisis virtually unscathed.

Politicians have come to appreciate the importance of having a strong central bank and realise that hyperinflation hurts the poor most of all. In addition, Lula’s government appears to understand the importance of disciplined fiscal and monetary policy.

However, structural problems remain. The most notable difficulties include widespread institutional corruption and violent crime, a weak legal system, damaging political influences and social inequality.

Economic strength also brings a risk of overheating. Money is flowing in from overseas investors, there is little slack in the economy and, with an eye on the election this year, the government is still spending on fiscal stimulus long after it is needed. This combination of a non-aggressive central bank, over stimulus and a strong economy could lead to a return of inflation through the backdoor. These issues form a significant part of Baillie Gifford’s considerations as we seek out attractive investment opportunities.
 

Potential areas of interest

Domestic consumption

While markets for oil and gas services or sugar ethanol are likely to develop further, a more interesting trend is the potential growth in domestic consumption. Consumer industries are highly fragmented, but there are some early signs of consolidation among gas stations, drug stores, healthcare suppliers and shopping malls.

Infrastructure

Brazil has historically underinvested in infrastructure. Meanwhile, the population has almost doubled in the last forty years, the country has become a massive exporter of resources and it has won the right to host the football World Cup and Olympic Games. Brazil is approximately the same size as the US excluding Alaska, and has the world’s third largest road network of which only 12% is tarmac. An upturn in infrastructure spending is likely to favour companies involved in areas such as building materials and merchants or plant hire. 

Housing

Brazil has a young population and a shortage of housing. The government has begun a programme of subsidised housing and home loans. Similar schemes elsewhere have lasted for many decades and a repeat in Brazil will be beneficial for the many well-run house builders.   

Private equity 

Brazil has some very able private equity firms. The absence of easy credit means these companies must add value to the companies they own by installing well-incentivised management or providing capital to allow a business to restructure or consolidate. 

Backdoor Brazil 

It may also be worth keeping an eye out for companies elsewhere in the world with Brazilian subsidiaries which may be undervalued or suitable for flotation on the local stock market. Given the large German and Japanese communities, there may be some opportunities of this nature in those domestic markets.

To summarise, the market in Brazil is booming and is attracting unprecedented levels of investor interest. The situation does call for caution, particularly as some of these businesses have no record in a severe crisis. However, the market is not expensive and significantly cheaper than China or India, especially considering the absence of borrowing. So, while this is certainly a boom, it may have a long way to go before it peters out and we retain our long standing enthusiasm for well-run Brazilian companies. 

Author: Colin Renton
Colin Renton is an investment writer in the Institutional Clients Department of Baillie Gifford. He joined the firm in May 2007 having spent the previous seven years in similar roles with two other investment managers. Colin has more than 20 years experience in financial services and holds professional qualifications from the Chartered Institute of Bankers in Scotland and the Chartered Insurance Institute. 

Stock market investments and any income from them can fall as well as rise and investors may not get back the amount they invested. Changes in the rates of exchange may cause the value of investments to go down or up.

Investments in emerging markets are only suitable for those investors prepared to accept a higher level of risk. This is because these markets could go down or up more than the main international markets.

The views that are expressed in this article should not be taken as fact and no reliance should be placed upon these when making investment decisions. They should not be considered as advice or a recommendation to buy, sell or hold a particular investment.
This article contains information and opinion on investments that does not constitute independent investment research and is, therefore, not subject to the protections afforded to independent research.