Brazil cuts interest rates and taxes to head off hard landing for its economy

The same day, November 30, that the People’s Bank of China reduced the amount of cash that big banks have to keep on reserve to 21% from a record 21.5%, the Banco Central do Brasil cut actual interest rates for a third straight meeting. Today, December 1, the Brazilian government suspended a tax on foreign investment, and cut taxes on appliances, food staples, and consumer credit.

The goal of all this is to reverse a drop in Brazil’s growth rate that has started to worry the central bank and Brazil’s government—especially because the slowdown in European economies is expected to accelerate in 2012 with a good chance that the EuroZone will slip into recession. Brazil’s economy is forecast to grow at just a 3.1% rate in 2011. That’s quite a drop from the 7.5% growth of 2010.

Brazil’s central bank had raised interest rates to 12.5% in an effort to slow growth and reduce inflation to the bank’s target range of 4% plus or minus two percentage points. But now, even though inflation is still not under control (the annual rate of inflation was 6.69% in October), the bank has decided that the danger of Brazil’s economy stalling is great enough to reverse policy and begin cutting interest rates.

Yesterday’s move brings the benchmark Selic rate to 11%. In its post-meeting statement the bank signaled that this wouldn’t be the last cut either. The futures market is now pricing in a benchmark interest rate of 9.25% by July.

The Banco Central do Brasil didn’t give a growth target when it cut interest rates yesterday but the government did when it cut taxes today. The goal is to produce 5% growth in 2012 even with the slowdown in the global economy.

Like China, Brazil has decided to move to lower the odds of a hard landing for its economy.

It’s early. The results are open to revision and interpretation. And one month doesn’t make an investible trend anymore than a single swallow makes a spring.

But have you noticed? In the last month emerging stock markets such as China and Brazil have outperformed the U.S. market.

And that’s an absolute turnaround from results in 2010 and for most of 2011. Does it mean that we’re about to reverse the pattern that’s held for more than a year and see emerging markets start to outperform developed markets? Well, sort of. The picture right now shows that the outperformance is limited to some emerging markets and even in those markets, so far, the outperformance is spotty.

But I do think there’s the beginning of a trend here that your portfolio needs to respect. And since it’s so early, you need to pay attention to what kind of stocks in these emerging markets investors are willing to buy right now.

Here’s the data.

For the U.S. markets–for 2010 the Standard & Poor’s 500 stock index was up 15.02%. For 2011 to date, as of November 15, the S&P 500 was up 1.65%. In the last three months it gained 5.05% and for the last month 2.85%.

For Brazil—for 2010 the iShares MSCI Brazil Index ETF (EWZ) was up 7.69%. For 2011 to date as of November 15, it was down 19.54%. In the last three months the loss was a more modest 2.80% and in the last month the index climbed 4.35%.

Yep, after trailing for 2010. After getting killed in 2011 to date. After trailing badly over the last three months. In the last month the Brazil index beat the U.S. market.

China shows the same pattern—with some important wrinkles. Read more

Update Itau Unibanco (ITUB)

On November 1 Brazil’s Itau Unibanco (ITUB) reported third quarter adjusted net income, which excludes one-time items, of 3.94 billion reais (or $2.3 billion). That was up from 3.16 billion reais in the third quarter of 2010. That’s a 24.7% increase. The results also easily beat the analyst estimate of 3.65 billion reais for the quarter. (Reais is the plural of real.)

Great numbers.

But before you rush out to buy these shares—and the stock is a member of my long-term Jubak Picks 50 portfolio http://jubakpicks.com/jubak-picks-50/ –you need to get your head around this number. In the quarter the bank posted an annualized return on equity of 22.7%. That was up from 22.2% in the second quarter. As you’d expect that measure of profitability at Itau obliterates the return on equity at troubled U.S. banks. The comparable measure at Citigroup (C) is just 6.72% for the last 12 months and a negative 1.45% at Bank of America (BAC). But it also humbles the profitability at some pretty good U.S. banks. JPMorgan Chase (JPM), for example, shows a return on equity of 10.9%, PNC Financial (PNC) 11.92%, and U.S. Bancorp (USB) 14.24%.

That ought to raise a big screaming question in your mind—Is the Itau Unibanco story that good? Or is there some huge burden of risk hanging over the stock that means you shouldn’t buy it even with that kind of differential in profitability? Read more

Buy CPFL Energia (CPL)

The recent pull back of about 10% in the Brazilian real versus the U.S. dollar has removed some of the currency risk from owning Brazilian utility CPFL Energia (CPL) for its 6.5% yield. And the recent interest rate cut from the Banco Central do Brasil suggests that interest rates are headed modestly lower in the medium term—which is likely to push up the price of income producing utility stocks as investors in Brazil looks for more income. The combination makes CPFL Energia, which trades as a reasonably liquid ADR in New York, an attractive income-producing total return proposition, in my opinion, for a portfolio such as my Dividend Income portfolio http://jubakam.com/portfolios/ . (I included this stock in my recent post “Lemons into lemonade: High yield stocks from today’s market rout for tomorrow’s retirement portfolio” http://jubakam.com/2011/09/lemons-into-lemonade-high-yield-stocks-from-todays-market-rout-for-tomorrows-retirement-portfolio/ .)

CPFL Energia is Brazil’s largest private power distributor with about 13% of the national market. About 75% of operating income comes from regulated electricity sales, which provides a high measure of revenue predictability. (These rates aren’t set for regulatory review until late 2013.) The company’s customer base is concentrated in the traditionally fast-growing Sao Paulo and Rio Grande do Sul states, which gives CPFL Energia a good shot at growing revenue faster than the national economy. Credit Suisse projects 2011 revenue growth at 7.1%.

Many of Brazil’s electric utilities face a price squeeze as new capacity comes on line at a pace that looks like it will outstrip the growth rate of demand. CPFL Energia is well positioned to avoid that problem because it is not only the most efficient distributing company among publicly-listed utilities (with a return on invested capital for 2011 projected at 15.2% by Credit Suisse), but also has contracted just about all of its generating volume for the next 20 years. In addition the company is moving strongly and quickly into alternative energy production. For example, the company has formed a joint venture with Energias Renovaveis to develop wind, small hydro, and biomass projects.

The New-York-traded ADRs (American Depositary Receipts) selling at $24.48 today, September 20, trade near the bottom of their 52-week range of $22.84 to $30.66. The units pay a yield of 6.5%. The only downside, and this may have an influence on your timing, is that the company will pay out its first half dividend on September 30 to shareholders of record as of August 17.

Full disclosure: I don’t own shares or units of any of the companies or partnerships mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post.  The fund did not own shares of CPFL Energia as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

Sell Cosan (CZZ)

On September 28 I argued that the odds are good that Brazilian and Chinese stocks will out perform their developed economy peers over the next year on the faster growth rates of those economies. And I said that the best place to be in those emerging markets was the shares of domestically oriented companies. In other words you want to buy shares of companies that sell to prospering Brazilian and Chinese consumers rather than shares of companies that sell for export into the slowing global economy. (See my post http://jubakpicks.com/2011/09/09/are-china-and-brazils-stocks-about-to-race-away-from-slow-growing-developed-markets/ )

Well, since I don’t have a rich uncle who gives me a paper bag of cash whenever I want to buy a stock, buying domestically oriented companies means selling something else. In Brazil right now I think that means selling shares of Cosan (CZZ in New York and CSAN3.BZ in Sao Paulo).

In the short term sugar production in Brazil is down. Output in the first two weeks of August in Brazil’s Center South region, the world’s biggest producing region, fell by 3.4% from the same period last year. The harvest, which stretches from March through November, is on track to be 10% or more smaller than last year.

In the short term the price of ethanol made from sugar faces downward pressure from lower global oil prices. Ethanol competes with gasoline as a fuel in Brazil so lower gas prices convince some consumers to switch.

Smaller production, lower global demand, and pricing pressures don’t bode well, in the short term, for Cosan and its huge Raizen joint venture with Royal Dutch Shell (RDS).

In the long term, however, the tough times for sugar and ethanol producers will help Raizen expand its share of the markets. Read more