Breaking Down Brazil

Most of my posts have been focused on China and US. This one will be centered on specific indicators that I use to follow Brazil.

In this post I’ll discuss:

  • Indicators of focus separated into Leading, Coinciding, and Lagging
  • Charts for each indicator
  • Summary and specific notes about each indicator

While Brazil is down 25-30% from the January peak, to me, we are still early in the move based upon my analysis.

MSCI Brazil (weekly chart)
Source: Bloomberg

 

Indicators of Focus

On a relative basis, Brazil vs the S&P 500 is near the lows seen in 1999, 2002, and 2016.

MSCI Brazil vs S&P 500 (monthly chart)
Source: Bloomberg

Meanwhile, the currency (USD/BRL) is approximately 15% from the 2016 highs.

MSCI Brazil vs S&P 500 (white), USD/BRL (inversed, yellow) (daily chart)
Source: Bloomberg

To help explain what has been driving the performance of Brazil, there are eight indicators that I focus on that I separate into Leading, Coinciding, and Lagging.

Leading Indicators (tend to inflect before the change in relative price)

  • China’s M1
  • Brazil’s Terms of Trade
  • Brazil’s Industrial Production and Manufacturing PMI
  • Brazil’s exports
  • Brazil’s Credit Default Swap (CDS)

Coinciding Indicators (tend to inflect with the change in relative price)

  • Currency (USD/BRL)
  • Emerging Markets OAS

Lagging Indicator (tend to inflect after the change in relative price)

  • Relative Fundamentals

 

Charts for Each Indicator

China’s Impact on Brazil

Since China accounts for ~20% of all Brazil’s exports, what happens in China directly impacts Brazil.

Comparing China’s M1 Money Supply to the relative performance of Brazil vs the S&P 500, Brazil saw significant outperformance from 2002 – 2010 when China’s economy and M1 was growing tremendously. However, as China has slowed since 2010, the relative performance of Brazil has been the complete opposite of the prior period.

China M1 (blue – 1ma, red – 3ma, green – 6ma, yellow – 12ma)
Source: Bloomberg

MSCI Brazil vs S&P 500 (monthly chart)
Source: Bloomberg

As seen over the past 10 years, if the growth rate of China’s money supply is declining than the probability of global trade (i.e. demand) increasing is extremely low.

China’s M1 12ma, Y/Y (light blue), Australia (blue), Brazil (green), South Korea (red) (note – country data Y/Y and 6 month average)
Source: Bloomberg

Manufacturing and Trade

While both are broad indicators of potential global demand, I do watch ISM Manufacturing and Japan’s Leading Index. Currently, it seems that both peaked 4-6 months ago.

MSCI Brazil vs S&P 500 (white), ISM Manufacturing (yellow), Japan Leading Index (green) (monthly chart)
Source: Bloomberg

Turning to Brazil specific data, Industrial Production and Manufacturing PMI are showing signs of additional slowing after peaking about 6 months ago. (note – image shifted so it can be compared to the previous chart)

As shown in the second China M1 chart, the growth rate of Brazilian Exports is slowing and looks similar to the 2000-2001 period.

Brazil Exports: blue – 3ma, Y/Y; red – 6ma, Y/Y (monthly chart)
Source: Bloomberg

MSCI Brazil vs S&P 500 (monthly chart)
Source: Bloomberg

Similarly, Brazil’s Terms of Trade (value of exports relative to the value of imports) is declining.

MSCI Brazil vs S&P 500 (white), Brazil Terms of Trade (yellow) (monthly chart)
Source: Bloomberg

Credit Risks

Starting with the broad indicator of Emerging Market OAS, we see that spreads are still very tight for Emerging Markets.

MSCI Brazil vs S&P 500 (white), Barclays Emerging Markets OAS (yellow) (daily chart)
Source: Bloomberg

More specifically, Brazil’s 5yr Credit Default Swaps (CDS) is showing stress but it is still a long way from the levels seen in 2008 and 2015.

MSCI Brazil vs S&P 500 (white), Brazil 5yr CDS (yellow) (daily chart)
Source: Bloomberg

Relative Fundamentals

Turning to the relative fundamentals, there is about a 6 month lag from when China’s M1 increases to when Brazil sees a higher sales growth than the S&P.

Quarterly Chart
Source: Bloomberg

However, investors haven’t been rewarding Brazil during the higher growth periods.

MSCI Brazil vs S&P 500 (higher sales growth periods circled) (daily chart)
Source: Bloomberg

Turning to Operating Margins, when China was seeing strong growth (2002-2010), the relative profitability didn’t matter to the market as it was primarily focused on growth. However, that changed around 2011. Since then, when relative profitability declined, so has the relative performance of Brazil.

MSCI Brazil vs S&P 500 (white), Operating Margins: Brazil vs S&P (yellow) (monthly chart)
Source: Bloomberg

 

Summary and Notes about Specific Indicators

Comparing the leading indicators to 2000-2002 and 2014-2016, this trade seems to be in the early stages.

Leading Indicators

  • China’s M1 – Currently not looking to reaccelerate, staying focused on 6 and 12 month average
  • Brazil’s Terms of Trade – Bottomed long before others indicators in 2001 and 2015. No sign of that occurring at this time
  • Brazil Industrial Production and Manufacturing PMI – Would expect PMI to bottom before IP but that wasn’t the case in 2015-2016.
  • Brazil’s exports – Growth rate still declining and I would expect the 6ma to continue to slow
  • Brazil’s CDS – Small reversals are to be expected, staying focused on bigger move later in the slowdown, waiting for a lower high before fully closing trade.

Coincident Indicators

  • Currency (USD/BRL) – Will probably confirm the lower high of Brazil’s CDS, like in 2016
  • Emerging Markets OAS – Will probably confirm the lower high of Brazil’s CDS, like in 2016

Lagging Indicators

  • Relative Fundamentals – Only a lagging indicator because of the need for companies to report

 

Until the Leading Indicators begin to turn, I would continue to expect Brazil to underperform and would not recommend allocating money to Brazilian Equities despite the Index being 25-30% off the January high.