Updated March 30. It looks like Brazil’s impeachment rally is back on after a week when it looked like President Dilma Rousseff might be able to slow or divert the process.
Yesterday, March 29, the Brazilian Democratic Movement Party (PMCB) voted to withdraw from the Rousseff government. The PMDB, the largest party in the coalition government, controls six ministries and all those officials will tender their resignations. PMDB President Michel Temer is also the country’s vice-president and would replace Rousseff if she were impeached or resigned.
Last week Rousseff had struck back at her opponents–and Brazil’s legal system–by appointing her predecessor and mentor Luiz Inacio Lula da Silva as her chief of staff. That conferred wide legal immunity to Lula, who is facing charges in Brazil’s ever widening corruption scandal. With a position in the Rousseff government Lula is immune to prosecution except in front of the country’s supreme court, which is know for moving at pre-global warming glacial speed in such cases.
But instead of slowing the impeachment process Rousseff’s move this week looks to have galvanized outrage over corruption in the Rousseff government (and by other politicians) With millions of Brazilians taking to the streets in protest the PMDB was pushed to join the impeachment camp. The lower house of Brazil’s legislature is expected to vote on articles of impeachment in mid-April with an impeachment trial in the Senate to follow, unless Rousseff resigns, in May.
Brazil’s political turmoil has made it impossible for the country to address runaway inflation and a persistent recession, and any sign of a Rousseff impeachment has been greeted with excitement at the financial markets because it promises to break that deadlock.
That’s the case today, for example, when shares of Itau Unibanco (ITUB), the country’s biggest private bank, were up 2.06% as of noon New York time. The shares finished up 0.8% on the day.
I expect that an impeachment rally could easily run through the vote in the lower house this month and to the trial/resignation in May.
But fixing Brazil’s political problems will require more than a Rousseff departure. Many of Rousseff’s most outspoken opponents have themselves been dragged into the anti-corruption investigation and it’s unlikely that any successor government would be able to mobilize the support needed to impose big cuts to the government budget and to pass and then implement the reforms that Brazil’s economy needs.
There’s a good chance, therefore, that the impeachment rally will lead to disappointment once Rousseff herself is off the stage.
I’m holding my Jubak’s Picks position in Itau Unibanco to catch the last stages of the impeachment rally. I’d certainly consider selling on the news of an impeachment vote or resignation.
Update March 14, 2016. The New York traded ADRs of Brazil’s Itau Unibanco (ITUB) were up 37% for 2016 to date as of the close on March 11. Most of that move has taken place in the last couple of weeks. Since the close on February 26 at $6.14, the ADRs (American Depositary Receipts) were ahead 45.9%
The ADRs fell 1.9% today, March 14. More on what that might mean later in this post.
What has driven the gains?
Certainly not Brazil’s improving financial picture. On February 26, the very day that Itau Unibanco started its big upward move, Moody’s Investors Service downgraded 29 Brazilian banks, including Itau, on a cut to Brazil’s sovereign debt rating to junk, and a continued deterioration in bank profitability, asset quality and capitalization. (Standard & Poor’s cut Brazil to junk status in September and then downgraded the country’s credit rating again in February. Fitch Ratings cut Brazil to junk in December.)
Certainly not a pickup in Itau’s big credit card business, a market that Itau Unibanco dominates in Brazil and in Brazil’s Latin American neighbors. The credit card processing market will grow at just low single digits this year, Itau said on March 3.
And certainly the bank’s fundamentals continued to decay in this period. On February 2 Itau Unibanco reported fourth quarter earnings and guided to a 17% drop in net profit this year. Even that guidance might be too optimistic since it assumes credit conditions in Brazil won’t get much worse. If the bank’s guidance for 2016 profit is accurate, Itau Unibanco’s return on equity at 17.5% will fall below the bank’s cost of capital.
So why are the ADRs up nearly 46% in two weeks?
Thank Brazilian President Dilma Rousseff–or more precisely rising expectations that she will be impeached not very far down the road.
Investors and traders have been down this path with President Rousseff before. In 2014 when she was running for reelection, every dip in her standing in the polls resulted in a move up by Brazilian equities. In 2015 when it looked like Dilma might face impeachment proceedings, every dip in her approval rating led to a rally on the Sao Paulo market.
In 2016 impeachment seems extremely likely and Brazilian financial markets have advanced strongly on the idea that with Dilma out the current gridlock in Brasilia will break and the country can get its fiscal house in order, beat back run away inflation, and restore growth to the economy.
You can feel the likelihood of impeachment settling in around Dilma as the pace of a corruption probe named Operation Carwash accelerates. On February 22, Rousseff’s top campaign strategist, João Santana, was arrested for allegedly receiving $7.5 million in a bribery scheme at national oil company Petrobras, which is at the center of the scandal. Then magazine IstoE reported that the government’s former leader in the senate, Delcídio do Amaral, had told prosecutors as part of a potential plea bargain that Rousseff had pushed judges to release political allies imprisoned on charges of graft. On March 4, Federal Judge Sergio Moro had former President Luiz Inácio Lula da Silva detained for questioning about favors he and his family allegedly received, and on March 9, a state prosecutor charged Lula with money laundering and hiding assets.
Dilma’s allies are deserting her. The Democratic Movement Party, or PMDB, Rousseff’s largest ally in the ruling coalition, will discuss voting on ending ties with Dilma or, at the least, setting members free to vote for impeachment, in a national convention on March 12. Her opponents are planning nationwide protests on March 13 to call for her impeachment. Rousseff’s deputy leader in the lower house, Silvio Costa,says he still has enough votes to defeat a formal impeachment request, but the margins seem to be eroding. Think tanks in Brazil say the odds are now 55% to 65% in favor of an impeachment.
The thinking in the financial markets is that a Dilma impeachment would break the gridlock that has prevented any action on reducing Brazil’s government deficit or attempting an economic stimulus plan or tackling inflation. Inflation hit a 13-year high of 10.7% in 2015. On March 2 the Banco Central do Brasil left its benchmark Selic rate at 14.25%. The Brazilian economy has been in recession since the second quarter of 2015–as you might expect with interest rates of 14.25%. But the Dilma government and the national legislature have been unable to agree on anything that might effectively tackle the country’s economic problems. In the last 14 years government spending as a percentage of GDP increased from an already hefty 18.6% to 20.2% in 2014. (In Mexico, by comparison, state spending accounted for only 12.2% of GDP in 2014.) Social programs, infrastructure and public pensions ate up 13% of GDP in 2012. Those programs helped raise 40 million poor Brazilians into the middle class in the last decade but many of those are now threatened with sliding back from those ranks.
It would be nice to think that removing Rousseff, her party, and her allies from power would fix all–or indeed any of this. But the truth is that Brazil’s political class as a whole is deeply committed to a system that uses state resources to grease the wheels of power. There’s not much disagreement among non-Brazilian economists that necessary structural reforms include reining in government subsidies at the Brazilian Development Bank reducing energy subsidies, raising the retirement age or reforming public pensions, and cutting transfers from the national to state governments. Without these reforms, I don’t see Brazil recovering its investment grade credit rating–won with so much struggle–short of new boom in global commodities strong enough to paper over the economy’s basic problems.
On Sunday, March 13 somewhere between 3.6 million (police estimates) and 6.9 million (protest organizers) Brazilians took to the streets to demand that Dilma resign or be impeached. The Braziian supreme court is set to clarify the impeachment process on Wednesday and the lower house of Brazil’s legislature is likely to convene an impeachment committee shortly after that.
Today we saw a pull back in Itau Unibanco (1.9%) and in the iShares MSCI Brazil ETF (2.91%.) That could have been a sell on the news after the protests but I think it was more likely a reaction to weaker commodity prices and a stronger dollar. I think we’re likely to see still more euphoria in the financial markets as Brazil moves closer to an impeachment of resignation by President Rousseff.
That euphoria will then yield to the darker realities of the depth of the country’s problems and the likelihood that a new government won’t be magically more successful at passing a reform program that the Rousseff government has been.
I think it’s worth hanging on to shares of Itau Unibanco, a member of my Jubak Picks portfolio, for the likely buzz of an impeachment/resignation, but I’d certainly be thinking of selling on that news.
The good times that are likely to be priced into Brazilian stocks by that point will be very tough for anyone to actually deliver.
Why do I want to own Itau Unibanco (ITUB)? The company is a growing regional super bank in Latin America, picking up business as the biggest global banks shed assets. It is also likely to pick up asset market share in Brazil as the country’s big state-owned banks pull back in the current financial and economic crisis. Itau Unibanco owns two of the biggest credit card brands, Hipercard and Itaucard, in Latin America with 58 million accounts in Brazil in a region likely to show above average growth in consumer credit after the turn in Latin American economies. And as the largest private bank in Brazil, I think it is likely to pick up market share as state-affiliated banks cut back in and after this crisis.
Why don’t I want to buy these New York traded ADRS quite yet? Itau Unibanco has a great record in recent years of sticking with high quality assets and that has kept bad debt ratios from climbing even in the current economic plunge, but I don’t care how good your credit controls are a recession or a potential depression just isn’t good for a bank’s balance sheet.
I’m going to keep Itau Unibanco in my 50 Stocks long term portfolio as a long term play on the expansion of credit among a growing middle class in Latin America and on my read on the way that superregional banks like Itau are picking up market share as the biggest global banks sell off assets to meet tougher capital requirements from regulators. (I’d put this in a long-term silo labeled “Rise of global middle class.) But on my new 50 Stocks timing scale I’m going to rate this “Cheap but not cheap enough—Hold. (For more on where the bottom might be in Brazil see my subscription only JubakAM.com post from December 1 http://jubakam.com/2015/12/brazil-could-be-headed-for-an-honest-to-goodness-depression/ On November 13 I wrote that I’d like to buy this around the then bottom of the ADR’s Bollinger Band at $6.46. That means something like another 10% down from the December 1 close at $7.14. That still seems like a good entry to me.
As of November 16, 2015, I’m keeping Vale (VALE) in my long-term 50 Picks portfolio. If you hold the shares of this Brazilian iron ore producer, I’d continue to hold. If you were thinking of buying because the shares look so cheap at $3.93 today, I’d say “Not yet.” I’d look to buy the New York traded ADRs (American Depositary Receipts) at $3.30 or so—about 15% below the 52-week low. (Vale was a member of my 12-18 month Jubak’s Picks portfolio until October 13, 2014. I sold it on that date at $11.47.)
Two reasons to buy (or hold onto) Vale at these prices. First, the iron ore cycle will turn someday as growth in the global economy picks up and as demand/supply come back into balance. Second, Vale is expanding production at its Carajas mine, a project with one of the richest iron ore bodies in the world. Because the iron ore at Carajas is so rich it sells for a premium on world markets and it helps make Vale the low cost iron ore producer in the world. Add in cost reductions, the efficiency of the new truckless operations at Carajas, and China’s recent willingness to accept the extremely big ore carriers that Vale increasingly uses, and Vale has been able to reduce its cost by 15% in the most recent quarter to $34 a metric ton delivered in China. When the market for iron ore does finally turn Vale will be one of the big winners.
But the reasons to hold off on buying are more numerous.
First, the momentum in Brazil’s financial market is still thoroughly lower. ETF iShares MSCI Brazil Capped (EWZ) was down 35.07% year to date for 2015 as of November 13. Vale itself is down 33.6% year to date. Brazilian service and consumer sector leaders Kroton Educacional (KROT3.BZ in Sao Paulo) and Natural Cosmeticos (NATU3.BZ), respectively, are down 56.15% and 42.86% for the year. In the currency market the Brazilian real is the world’s worst performing currency, down 31% in 2015 to date. The country’s debt has been downgraded 4 times since 2014 by Standard & Poor’s, most recently to junk in September.
Second, the country’s economy is a mess. The economy is in recession and the Banco Central Do Brasil projects that GDP will fall by 2.7% in 2015 and by 2.2% for the four quarters ending with the second quarter of 2012. The bank projects inflation of 9.5% for 2015, way above the central bank’s inflation target of 4.5% give or take two percentage points. That forecast is built on the assumption that the Selic benchmark interest rate will be 14.25% during the period.
Third, the country’s politics are so convoluted with President Dilma Rousseff facing six (at last count) impeachment resolutions, that it is unlikely that the Brazilian legislature will tackle the country’s big problems (budget deficit, corruption, a bloated state sector, etc.) anytime soon.
And fourth, although iron ore prices will turn someday, they are still falling and it looks like supply won’t come into balance with demand until 2017 or 2018.
On balance this earns Vale a place in this long-term portfolio on the company’s potential. And a current rating of HOLD CHEAP BUT NOT CHEAP ENOUGH as of November 16, 2015. I’d put Vale in my cyclical commodity, and developing economy silos for its long-term trends.
What I posted on my paid site today–buy/sell/when on Brazil and the beginning of revisions to my long-term portfolio
Today, on my paid JubakAm.com site I posted a very long look at whether Brazil is cheap enough to buy now–it’s not I concluded–and gave my reasons for wanting to see another 10% to 15% decline before buying Vale and Itau Unibanco.
Besides offering an analysis of the Brazilian economy and market, this post is also the introduction of a new system that adds more timing to the fundamentals of my long-term 50 stocks portfolio. As I work my way through this portfolio, I’m going to add timing guidance–such as the “Cheap but not cheap enough yet” opinion Im going to add to the entries for Vale and Itau Unibanco in that portfolio. (I’m also going to weed out stocks where fundamentals have changed or the timing just looks too unfavorable. So I’m dropping Brazilian airline Gol.)
To read about Brazil, you’ll need a subscription to my paid JubakAM.com site.
The changes to the portfolio, however, will show up on both the paid site and on this free JubakPicks.com site. The bookkeeping will probably take me until Monday but after that you should see the changes to the portfolio on both sites. The next set of changes will go up next week in a post on the banking sector.)
That’s what I’m working on at my subscription JubakAM.com site–I think there’s some value to you in passing on the direction of my thinking about the market on that site. Hope so anyway. (There will be some new posts on the paid site over the weekend. I’ll summarize them for readers of my free site on Monday.)
Of course, there’s an ulterior motive to sharing this with you: If you decide that you’d like more detail on my JubakAM.com posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)