Bottom Line: Blame Lula (and buy Brazil)

By GREGORY FOSSEDAL, Special to UPI  |  Oct. 23, 2002 at 7:14 PM
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WASHINGTON, Oct. 23 (UPI) -- Countries facing a currency crisis are not generally a popular or safe place to invest your money. Add to that the likely election of a center-left president who in past campaigns has led work stoppages, toyed with the idea of repealing the country's national debt, and spoken ill of the Western banks and institutions holding that debt -- and you normally have the recipe for a great bear market, if not a constitutional crisis.

Such was the case in both Argentina and Venezuela over the last two years.

So why would nervous investors want to consider buying Brazil at this time? Lula da Silva, who fits the above description, is almost certain to be elected president (on his fourth try) in this Sunday's runoff election. The country already faces fallout from Argentina and Venezuela -- not to mention the Bush administration's steel quotas -- and has a currency-debt crisis that has deepened in recent months.

One answer is that in investing, to paraphrase John Maynard Keynes, the goal is not to pick the prettiest girl at the contest -- but rather, to pick out who the judges will later think is the prettiest girl. In the case of global equities, this means shorting countries that the judges have driven up too far (the U.S. in 2000, for instance), and buying those that they have battered down beyond reason. Have the judges driven Brazil down too far? And will they, accordingly, drive them back up in the months to come?

There are several fundamental indications that the answer to these questions is "yes." For one, unlike Argentina last year, Brazil has a floating exchange rate for its currency, the real -- which has already drifted off more than 30 percent against the U.S. dollar in recent months. When Argentina faced a trade-currency crunch last year, it had a fixed exchange system and -- this was the real problem -- had virtually no major domestic politician calling for a different exchange rate, but the same system. (What was called "re-pegging" under Bretton Woods, and was commonly done.) The only choices offered to Argentine voters were, 1. keep the system and the same onerous rate of exchange, or 2. blow up the whole system.

Brazil has already had a 30 percent "devaluation," against trading partners like the U.S. and even Argentina, and it can keep on making adjustments as it goes. This has helped Brazilian exports, and gives Brazilian Central Bank President Arminio Fraga or his successor more flexibility in the months ahead.

Brazilian equities, moreover, are down 35 percent from May -- meaning, in dollar terms, Brazilian companies are selling at 40 cents on the dollar compared to five months ago. Are these companies really worth 60 percent less? Not really. Most of them, in fact, have earnings and dividends such that the price-earnings ratio on many stocks is in the single digits. (State oil company Petrobras, or PBR in New York, is about 3-1.) These figures are extreme, on the low side, even by emerging markets standards.

But the real key to the matter is a reading of Lula himself. Is he a bona fide leftist who will blow up the economy, as a series of presidents have done in Venezuela and Argentina? Or have his series of failed presidential campaigns, running on a hard-core socialist banner, softened him -- and convinced Lula that moving to the center is not only good election strategy, but the way to govern?

Indications from Lula's intimates are, he is more of a Clinton figure. In fact, a Lula advisor told me last week, "he has modeled many of his ideas on Bill Clinton in the United States." When Clinton took office, however left wing some of his personal inclinations may have been, he put an immediate eye on the U.S. bond market and the strength of the dollar. The result, in combination with a GOP Congress, was the greatest bull market in U.S. history.

"Lula has done the same," an advisor points out, wooing the investment and business community in Brazil and, in fact, winning the endorsement of key industry groups throughout Brazil. He has, in fact, reportedly conferred with Clinton and his former advisors, according to more than one source on his campaign. (Neither former President Clinton nor advisors Paul Begala and James Carville could be reached for comment by deadline.)

Lula plans, shortly after the election, to hold a Clinton-like summit of labor and business leaders, shortly after the election, to deal with Brazil's economic semi-crisis -- and to find a brain-truster or two to help staff his administration: "Someone with credibility in the financial markets."

If so, Lula would show that he has grown in skill and judgment since his early years. And Brazil would be on a virtuous political and economic cycle. Given that the fears of devaluation or debt repudiation have already been substantially discounted, it could be that "the judges" will reverse their thinking, as quickly and decisively as they did with Clinton in 1993-94.

To boot, Lula already faces a Clinton-like Congress composed mainly of parties to the center and right of him. He will have to "triangulate" from the start.

The bottom line: Brazil is a buy now, while the pessimism is at its extreme. It's a hold through the election and the grace period of 2-3 months during which he will signal how his administration will deal with Brazil's $260 billion in debt, especially the portion of it that is coming due over the next six months (about one-third.) Then, re-evaluate.

"How do I make the play?" There are a number of good index funds available to even small investors, such as Brazil Fund (BZF) and the Morgan Stanley Brazil index fund (EWZ). As always, these predictions should not be the basis of any investment decision without first consulting your broker or other money-management professional, preferably at a firm that does not have an investment banking division.

About this feature: For editors and first time readers, this feature, a weekly column on global investing -- focused especially on emerging markets -- takes its origin in two conversations, one old, one recent.

The old conversation was with the late Treasury Secretary William Simon in the fall of 1980. A journalist was asking someone -- maybe another journalist -- how the election would turn out. "Oh, well, I never make predictions about the future," the guest said.

"No predictions about the future?," Simon harrumphed. "Making predictions about the future is practically all I do." Simon understood well what investing is about -- and proved it in several decades of acting as one of the world's foremost practitioners of that art. He was also gracious enough to call me "one of the world's foremost experts" on the International Monetary Fund, which is an added reason he gets plugged here, appreciatively but appropriately.

This feature will make predictions about the future. Hence its title, "Bottom Line." Investors should never make these predictions the basis for any particular purchase of securities -- do that with your investment advisor. But, this column will stick its neck out.

In fact, as manager of a fund that deals in emerging market, you have this added reassurance: Any of the predictions in this column represent positions my fund, the Democratic Century Fund, has already taken. "The bottom line" puts its money where its mouth is, and will suffer or enjoy along with the reader in any gains or losses.

The second impetus was a recent one with some of the editors at United Press International. We live in an age of globalization and other buzzwords about One World Market -- cliches which are, like many cliches, largely true. Yet our news coverage, especially financial news coverage, remains largely parochial and nationalist. There isn't much focus on global investing, and when there is, it's on a nation-by-nation or company-by-company basis.

That's a fine and necessary input for any investment strategy. As annual surveys by Morgan Stanley confirm, however, it's a highly incomplete one when it comes to world and especially emerging markets. By the Morgan Stanley calculation, about 75 percent of the gains or risk in any emerging market stock are based on how the country does. When you invest in Brazilian companies, in other words, you're basically going long or short Brazil. You may as well focus a lot of your time, indeed most of it, figuring out where Brazil is going, compared to other countries.

In short, "keep your eye on the ball." In emerging markets investing, country trends and policy-makers -- their wise moves and their foolish ones -- are the ball. And that's the bottomline.

(Gregory Fossedal is chief investment officer of the Democratic Century Fund in Washington and the author of Direct Democracy in Switzerland. His firm may hold some of the securities mentioned in this article. Individual investors should contact their own investment professional before making any decisions to buy or sell these or any related securities.)

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