Three Things We Like About Brazil
This piece was written in August, 2022
#1
Serious About Fighting Inflation
Inflation in Brazil is just over 10% (as of August, 2022). Brazil’s central bank has aggressively raised its short-term policy interest rate from 2.00% eighteen months ago to 13.75% today.
As a point of comparison, inflation in the United States is about 9% and the U.S. Federal Reserve has raised short-term rates from zero to 2.50%.
The real return of investing in Brazil’s short-term policy rate (that is, the interest rate after adjusting for inflation) is positive. The real return of investing at the short-term rate in the U.S. is negative. Many developed countries around the world resemble the U.S. with negative real short-term rates.
Brazil is oddly enough one of the more aggressive countries in fighting inflation and taking action to protect the value of its currency. Higher real interest rates tend to attract capital. Capital inflows are good for both the economy and the currency.
Inflation and interest rates in Brazil haven’t changed since we wrote this. Inflation in the U.S. has declined modestly. Rates in the U.S. are now 5%.
- Kent; April 2023
#2
Commodities-Based Economy
We believe natural resources and their role in the global economy are underappreciated in today’s digital world. The world needs natural resources like oil, copper, iron, and agricultural commodities like sugar, corn, beef, and chicken in order to grow and flourish. Meanwhile, physical and social factors are pushing up supply costs and creating barriers for suppliers of these vital raw materials.
We believe the world is in the early stage of a multi-year surge in commodity prices.
Brazil is among the leaders in the production and export of many of these natural resources and agricultural commodities. This too could lead to an influx of capital as well as an improving trade balance, both of which are positive for the economy and the Brazilian currency.
We still very much believe we are in the early stages of a multi-year commodity bull market.
- Kent; April 2023
#3
Financial Services Industry Being Disrupted
Brazil’s financial services industry is in the midst of a digital transformation. Digital-first new entrants are taking share from the country’s three big incumbent banks by offering unique financial services products over the internet. The incumbents are struggling to keep up.
This digital transformation is bringing real value to real Brazilians in the form of financial services that the big banks either were not providing at all or were not providing to the majority of Brazilians. The digital disruptors’ costs to serve clients are a fraction of what it takes the larger incumbents to serve clients. The disruptors, as a result, can profitably serve clients with a better product at a much lower cost.
When an industry goes through a rapid transformation, the incumbents are sometimes slow to respond to the new competition and the markets are sometimes slow to reflect the true value brought to the market by the disruptors. We believe both are happening in Brazil at the moment.
We are invested in three Brazilian financial technology companies at the moment. All three are taking share from the incumbent banks in Brazil. All three have awesome unit economics and should benefit from economies of scale as they grow.
Kent; April 2023
Advice from John Templeton
John Templeton once advised that the best investments are made at the time of maximum pessimism. Brazil is in the midst of a deep recession. Its inflation is running double digits. Its currency has lost 70% of its value versus the U.S. Dollar since 2011. Most publicly-traded equities in Brazil are down 50% or more in U.S. Dollar terms since 2012, a period when the S&P 500 is up over 4.5x. Short-term interest rates are nearly 14%. For all those reasons, the equity prices of many companies exposed to the Brazilian economy have plummeted. While maximum pessimism can only be confirmed in hindsight, things are fairly pessimistic in Brazil at the moment.
Meanwhile, the three elements of Brazil’s economy just described – its aggressiveness in fighting inflation, its commodity-based economy, and the transformation of its financial services sector - give us some optimism for the future.
Our Multi-Disciplinary Investment Process
Our investment process combines a top-down assessment of the global economic landscape with a bottom-up fundamental analysis of individual companies. While our investments are always underpinned by a fundamental analysis of the individual company we invest in, we use our top-down assessment to narrow the opportunity set when we search for new ideas, to help manage exposures at the portfolio level, and to aid in the valuation of individual companies.
Our assessment of Brazil from a top-down perspective suggests some little gems could exist among the beaten-down publicly-traded companies exposed to the Brazilian economy. We have two such companies in the portfolio today and are actively looking for more.
