Where can you find financial responsibility and sound fiscal policies these days?
Forget about the debt-ridden United States. Washington hasn’t even begun to address its deficit. The United Kingdom? The new Conservative/Liberal coalition government is still lying to voters about the extent of the pain to come. The Euro Zone? German taxpayers are counting up the bill they’re being asked to pay and questioning whether the euro is worth the price.
In general, I’d say, you have to forget about the world’s developed economies and look to the developing world where China, India, Poland, and Brazil, have their financial and fiscal acts together in a way that residents of the developed world can only observe with envy.
Brazil is perhaps the brightest—and most unexpected member of this group. It’s not so long ago that the country’s mix of low growth, high inflation, and run away government made the joke “Brazil is the country of the future. It always will be” hit too close to the mark to be very funny.
But now? Look at what the country’s president Luiz Inacio Lula da Silva announced this week.
Budget cuts of 10 billion real ($5.6 billion). Granted that the cuts are tiny, a mere 0.3% of GDP and therefore mostly symbolic. But even symbols are important and this one signals that the government isn’t going to leave the central bank to fight inflation on its own. And the timing of the cuts is especially significant: bond buyers had been worrying that the government would increase spending as the country neared October elections.
The bond market thinks the gesture means something. The spread between yields on two-year fixed-rate notes and two-year inflation-linked notes has narrowed this week by 0.14 percentage points to 5.6 percentage points, according to Bloomberg. That’s a sign that bond buyers believe that the government and the central bank are more likely to get inflation under control.
Last month the Banco Central do Brasil raised its benchmark Selic interest rate 0.75 percentage points to 9.5% (not extraordinarily high by Brazilian standards) in an effort to fight inflation that had climbed to an annual rate of 5.3%. No one expects that to be the last interest rate increase with the consensus calling for increases in the benchmark rate to total 4 percentage points before the bank is dones later this year. (For more on the interest rate increase see my post https://jubakpicks.com/2010/04/29/brazil-raises-interest-rates-as-emerging-economies-step-up-their-fight-against-inflation/ )
But the combination of an interest rate increase and a small government budget cut has already started to reduce expectations for future inflation. Yields on the fixed-rate notes due in 2012 have fallen to 12.37% since May 4. Bloomberg quoted Marco Freire, chief investment officer of Brazilian fixed income at Franklin Templeton Investimentos Brasil, saying he expects government notes due in 2017 to fall to a yield of 12% by the end of 2010 from 12.672 on May 13.
I think it’s a little too early to by Brazilian equities. The interest rate increases still to come will keep downward pressure on stocks. And continued turmoil in the Euro Zone will hurt emerging market stocks in general.
But keep Brazil on your radar screen for later in 2010. The economy is predicted to be growing at a 6.3% rate by the end of the year. If the Banco Central do Brasil looks like its got inflation under control by then, Brazil would be one of the few places in the world to look for sound fiscal and monetary policy and solid economic growth.
bsdgv,
That is an outstanding link, and I would recommend it to everyone here! Thanks for sharing.
> On the surface, that appears deflationary.
The Pragmatic Capitalism has a piece on the deflationary trend.
http://pragcap.com/a-deflationary-red-flag-in-the-u-s-dollar
jrb,
I’ve been looking at commodities, specifically some of the industrial metals and agricultural commodities. There’s been no movement upwards in those areas, in spite of large amounts of cash being thrown into the world’s economies by all the major countries. On the surface, that appears deflationary.
In addition, with the fall of the euro, the dollar has strengthened, and I expect both will continue to occur in the near future. This will create a counter-balancing effect to increased demand for gold. If the demand for gold tails off, then I expect to see gold enter a freefall in price. I have heard numbers as low as $800/ounce out there, although I doubt it will get that low. At about $1,000/ounce, bargain hunters will step in, possibly sooner.
Yx, thank you for the kind words regarding the crash.
You are right, the whole EU is deeply socialist at its core. Its leaders believe in a nanny state that controls every aspect of people’s lives from cradle to grave. The level of bureaucratic regulation of economy is very high, all the talk about free market and honest competition is just BS.
The laws are complex, constantly changing and unclear. The tax burdens are increasing (22% VAT on almost everything in Poland; the social security withholding currently stands at 42% of the salary).
And the “buffer” theory is wrong. Russia and Germany have ALWAYS conspired to divide Poland between them, they do not want any buffers, they want a common border.
That is why Lech Kaczyński was reaching out to the U.S.A, he knew that neither Germany or Russia can guarantee our security.
A Mad Pole:
Your comment is really a surprise to me. I thought Poland is doing better than other eastern European countries. I even thought about buying a Poland index at one time. But again your description fits perfectly well with all socialist countries that I observed. That’s the result of socialism. But I do have great sympathy for victims of the airplane crash. I really wish Polish who suffered a lot in the past do well.
To those who cheers EU’s new “good entries” and those who slams those who questioned the new entries:
“Flood” of bad news started to rise. “EU Break-up”, “EU Disintegration”….. Search on Bloomburg.com or reuter.com or timesonline.co.uk will yield out a lot of results for you.
Among the choices of “EU break-up”, “weak countries drop put” and “Germany gets out”, “weak countries drop out” is the easies and best choice. Because breaking up EU is too big, too drastic and unrealistic. (Asia’s rise has marginalized Europe and they need to bundle together to remain on international stage.) Germany’s dropping out will immediately turns Europe into “Germany v. the rest Europe” which is too scary. Therefore, let the weak countries drop out will be only choice remain. Plus, weak countries always can re-join EU once their conditions improve.
The whole EU mess shows that kind of union must be among countries of similar economic level. Debt or deficit is important measurement, GDP per Capita or Income per Capita should be even more important measurement of socio-economic development.
I understand East Europe (particular the former Soviet block) who suffered under Soviet are eager to joint the west Europe, but it may not be the best for geo politics. By westernizing central and east Europe, western Europe puts themselves in direct conflict with Russia. By expanding EU or NATO to Russia’s door step, EU or NATO is provoking hostility with Russia unnecessarily. (Imaging yourself in similar circumstance where everyone is in a group except you. How would you feel? Left-out? Isolated? Others are ganging up against you?) The result of EU or NATO’s eastward expansion is a very unpredictable Russia. Just think about N. Korea. The long time isolation of N Korea by its neighbor Japan and S Korea is at least partly responsible for N Korea’s behavior. N Korea is extremely isolated. Long isolation of anyone causes strange behavior. Therefore, central and east Europe should stay “neutral” and independent from either blocks.. The neutral and independent Central and East Europe provides both Russia and western Europe a “buffer”. That’s why China can never dump N Korea while US military stationed in S Korea and another US military ally Japan just short distance away. N Korea is a buffer for China. (Additionally China doesn’t want flood of N Korea refugees if things collapse.) To restore investors confidence toward Euro (the currency) and the investment market in general, I have not seen better ways. If anyone does, please let me know.
To keep it short: the Polish government and Ministry of Finances are cooking books as well.
Social Security is already bankrupt, it takes over 20% of the country’s budget to keep it afloat, the government-run health care is a black hole, sucking in enormous amounts of money while the quality of service is constantly declining. There is a huge unemployment, the wages are low, so there is almost no domestic demans and strong Polish zloty makes exporting nearly impossisble. The government is singing praises but most everyone knows it is all BS.
Since we are not in the euro zone, the blowout should not affect European or global markets.
Jim,
I’d say that it is probably time to begin dollar-cost-averaging into Emerging Markets, if you’re not already doing so. The flow of money from the Euro will likely wind up either in Emerging Markets (which are much better priced than they were in January) or in the US dollar. A stronger dollar will benefit Emerging Market economies which export to the USA. Even without these effects, Emerging Markets are a very attractive growth story, so if you have cut back on Emerging Markets contributions or underweighted the sector, now is the time to begin ramping back up.
I also agree with you and several other folks who post here that it may be time to take profits in gold. However, as we can all attest, “mania” tends to last longer than rational. So I wouldn’t doubt there is more upside in gold — the problem is that the remaining upside potential in gold is becoming more risky and harder to assess compared to the upside potential offered by stock in many of the terrifically-run companies out there. So, if you’re overweight gold (likely that means greater than 4-6%), I would think about taking profits to bring yourself to an equal-weight or under-weight position. FULL DISCLOSURE: I am underweight gold / gold stocks based upon my definition above.
I don’t think gold is a bad place to be right now.
Speaking of gold,, where are all the naysayers of gg. Thanks Jim, I added on your advise. Have done very well on gg in last few years.
Interested to see if Jim will rotate from STO to PBR as stocks recover…..
I bought some BP yesterday. Should wait till today. A company like BP will get over it. Given that the energy sector is undervalued in my opinion.
Yeah, i’m thinking about jumping on RIG on monday, 7.5 P/E ratio vs average of 18.4 for the rest of the sector. Jim pointed out that RIG’s costs from the blowup are only about 1% of revenue. Looks like BP will take most of the liability hit from the spill.
marr.bo:
I have a small position in BP and missed my chance to sell and was waiting for the bounce that has not happened yet to sell. It’s dropped enough now that I’ve considered picking up instead, mainly for the 7% DY. But having watched it fall of the cliff, I’m not sure when it will hit bottom. Plus, I’m a little concerned about their ability to keep up their dividend, especially as clean-up costs keep escalating. The way the CEO has responded to the accident has not exactly inspired much confidence either.
EdMcGon:
I thought I read a post by you just a few days ago saying you were still into gold, and that your decision to sell gold was based on whether the Fed raises interest rates. But you seem to have quickly changed your mind. Can you elaborate on why the sudden change of heart? Thank you.
I wonder at what point BP and RIG become good value buys? I was reading an article where a prominant LA hedge fund is starting to pick up shares of BP. Extremely low P/E right now. Thoughts?
What may have caused last week’s meltdown? See the link.
http://www.reuters.com/article/idUSTRE64D42W20100514
Market is dropping like rock. Hope not another 5/4. God blesses us all.
Ed:
Agree. But our corruption is not much better.
In other news, get out of gold now. The run is about to peter out, and I’m not sure how far it will drop. There are still deflationary pressures in the world economy (i.e. too much industrial capacity with too little consumer demand).
Don’t fall too much in love with Brazil folks. They still have political corruption issues comparable to China. However, for fiscal policy, there aren’t any countries I know of that are more conservative. Kudos Brazil!
One thing I admire about Brazil’s president Lula is that despite his humble background, he understands the importance of private business. (He lived on Rio’s street, worked through union, as I read.) Once in power, he did not go to revenge or redistribution mode. Instead he adopted very pro-business policies. The result is the Brazil we are seeing now, prosperous than ever.
I sold some and still have some Brazil stocks, will not mind to buy more.
Brazil reminds me of China 10 years ago, the potential is so immense.