Why Brazil is 4x Better Than China

The #1 Market of 2008: Why Brazil is 4x Better Than China

Fellow Investor,

April's rally in global stock markets notwithstanding, the scorecard for global markets so far in 2008 makes for grim reading. Not a single European market is up so far this year. In Asia, only Taiwan and Pakistan are showing any gains. Latin America is the region that stands out, with Mexico, Chile, Colombia and Brazil all in positive territory. With both China and India down by as much as a third, and Russia down 10.7%, Brazil's 11.2% return to date stands head and shoulders above its BRIC rivals.

That Brazil is continuing its already remarkable bull run shouldn't come as a surprise. In the past five years, roughly since President Luiz Ignácio Lula da Silva took office amid fears he would crash the economy, Brazil has been a nine-bagger for U.S. investors. For all the press about China, investors in Shanghai have barely doubled their money over the same period.

So what explains Brazil's stellar performance? First, Brazil never reached the sky-high valuations of China. At the end of 2007, Brazilian stocks traded at a trailing P/E of 15, while Chinese stocks traded at a P/E of 27. Even after the Chinese market almost halved in value, it remained considerably more expensive than its Brazilian counterpart. Second, Brazil's index is heavy on big commodity names like Petrobras (PTR) and iron-ore producer Vale (RIO). The shares of these companies have soared on the back of the commodity boom.But here's the secret behind the Brazilian boom. Value investors know that the best companies don't necessarily make the best investments. Their quality already is reflected in the market price. The same principle applies to countries. When expectations are low, markets are cheap. And beating those low expectations drives huge stock market returns. That's why investors clean up by investing in "basket case" countries like Brazil and Russia, rather than by investing in "stars" such as China.

The #1 Market of 2008: The New BRIC Star

Even more so than Russia, Brazil has been the redheaded stepchild among the BRICs. Not only has Brazil been an economic laggard in terms of growth, but it also was the only BRIC country without an investment-grade rating. That all changed last week when rating agency Standard & Poor's awarded Brazil a BBB- credit rating. That single upgrade sparked a 6.3% jump in Brazil's Bovespa, soaring to an all-time high. The rise in the value of the market on that single day was greater than the value of the entire Bovespa in 2002.

Achievement of an investment credit rating is a watershed in the history of a developing country. As Guido Mantega, Brazil's finance minister put it: "Brazil now enters the club of the most respected countries, of the countries that are considered serious." Equally importantly, it also opens the floodgates of money from some of the biggest global pension and insurance funds. U.S. fixed-income investors, including pension funds and other institutional investors with some $2.6 trillion, will join the fray when a second ratings agency -- either Moody's or Fitch Ratings -- also upgrades the country. But that will come soon enough. Fitch Ratings has a team of analysts in Brazil at this very moment.

Once a poster child for the Latin American debt crisis of the 1980s, Brazil's fiscal budget today is in a surplus and the country is a net creditor. Inflation has plummeted from the triple-digit percentages of the 1990s to just 4.5% in 2007. Thanks to booming commodity exports, Brazil today boasts large-trade surpluses and dollar reserves that approach $200 billion. Soaring foreign direct investment, currently on track to match last year's record of $34.6 billion, will more than cover this year's projected current account deficit. Even though 33% of Brazilians live in poverty, domestic demand has risen strongly during the past two years, fueled by lower employment, higher wages and cheaper credit.

The #1 Market of 2008: Brazil A New Oil Superpower?

Brazil's President Lula da Silva, a former union leader with a fourth-grade education, has publicly attributed his country's newfound success to a "higher power." It's easy to see where divine providence has had its hand in the recent colossal oil discoveries that will complete Brazil's transformation from a barely self-sufficient producer into one of the world's major crude exporters.

Spectacular oil and gas discoveries are becoming the norm in Brazil. In November, Petrobras announced the discovery of the offshore Tupi field, with confirmed reserves of five billion to eight billion barrels. That find soon was followed by Jupiter, a natural gas area that Petrobras says is as big as Tupi. Last month, the head of Brazil's government oil regulatory agency, revealed "unofficial" figures from a new reservoir, known as Carioca, which may hold 33 billion barrels of oil and gas. If confirmed, that would make Carioca the world's largest discovery in at least 32 years, and trail just two larger oil reservoirs in Saudi Arabia and Kuwait. Put another way, that single field potentially could top all the proven reserves in the United States, catapulting Brazil into the world's oil-producing elite, ensconced between Nigeria (36 billion in reserves) and Venezuela (80 billion in reserves).

S&P's recent upgrade notwithstanding, Brazil has its challenges. The government continues to play too large a role in the economy. Public debt is still high compared with other emerging market economies. And the relentless appreciation of Brazil's currency, the Real, could hurt exporters. And as for lottery winners, good fortune is a double-edged sword, especially given Brazil's reputation for backtracking on reforms. Brazil must work hard to avoid the "oil curse," the dependence on one resource that dominates countries such as Nigeria and Venezuela. Nevertheless, kudos to Brazil for earning its way into the ranks of investment-grade countries. And kudos to investors who recognized the enormous profits to be made in Latin America's emerging economic giant.

Sincerely,

Nicholas A. Vardy
Editor, The Global Guru