March 11, 2016    3 minute read

Brazil At The Crossroads

   March 11, 2016    3 minute read

Brazil At The Crossroads

2015 has been a tough year for emerging markets and 2016 won’t be any less challenging according to the forecasts of the major investment banks. Sooner or later this trend will revert. Investors know and are waiting for signals from the market, some point where the economic trend would eventually take the opposite path to that of the recent systemic slowdown.

Brazilian market overview

To understand why this occurrence may hide a kink point in Bovespa Index, let’s first analyse what is happening in the heart of the South America. Inflation is currently running at 10.7% and despite this unexpected performance, the Central Bank decided not to level up the interest rate (or Selic Tax) previously fixed at 14.25%. This action was undertaken to perhaps avoid a further increase in the country’s mounting debt in foreign currency. The problem of the inflationary force is that goes against the other fundamental variables; it, therefore, increases market volatility and uncertainty in financial markets. Low commodity prices and globalisation, for instance, are driving disinflationary forces around the globe, hedged only by large Central Bank expansionary monetary policies such as quantitative easing. In addition to weak global demand, corruption is what is hitting Brazil the most, leading the country in its deepest slowdown in 25 years, with the economy shrinking by -3.8% in 2015.

Corruption spreads where there are huge capital inflows: Emerging markets

Corruption, generally speaking is one of the main diseases that developed countries suffer from: it creates market inefficiency, it destroys potential growth and brings to uneven capital allocation amongst social classes. It’s not a case that Brazil, Russia, China, India are badly ranked according to the Corruption Perception Index (CPI) 2015.

Market reaction to Lula’s detention

Lula da Silva, the former Brazilian President has been detained March the 4th by Brazilian Federal police in Petrobras probe. The country’s most popular leader of modern times was detained for questioning by Federal Police after an early-morning raid on his house as the Lava Jato corruption scandal reached the heart of the nation’s political sphere. Even if it looks like a drop in the ocean, the market reacted positively to the news. The Bovespa Index inverted its intraday trend up to +4% with Petrobras shares skyrocketing to +11.68% after the news was released by local media. The temporary detention seemed to be seen by the market as a possible kink point for short term analyses.

 

bovespa index

March 4th Intraday chart: Bovespa Index responded positively (+4.01%) to Lula’s detention news (Source: Yahoo finance)

Deutsche Bank recently advised to still hold a neutral position and wait for the outcomes of the political turmoil that may ensure in upcoming weeks. Whether this event is a kink for long term opportunities or not, it’s early to say. Brazilian economy is under the strict watch of the market makers’ eyes. Moreover, after a detrimental 2015, they need to outperform the market to offset the losses and restore investor sentiment: increasing redemption fees or locking capital up within the company’s wall can’t be a profitable solution in the long run. Sometimes their investment decisions are driven by irrational exuberance and sometimes by simply common sense. Brazil is going through some historical changes in these weeks, the market felt already, let’s see what investors think about it.

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