9 December 2014
Ben Gutteridge, Head of Fund Research at Brewin Dolphin discusses his positive outlook for India in comparison to Brazilian funds.
“Emerging markets are a difficult equity space to shed light upon as it not an homogenous asset class, however, it is of our opinion that Latin American generalist funds and Brazilian funds are unappealing, and would much rather be bullish towards, for example, the Ocean Dial Gateway to India Fund.”
Bye Bye Brazil
Our primary concern within Latin America is the fortunes for the Brazilian economy and its stock market. Having frequently commented on the negative outlook for Brazil, and successfully predicting the nation would fall into recession, we see no catalyst for a turnaround, and expect continued malaise and disappointing equity returns – certainly relative to India.
Commodities
Looming large in the commodities market is decreasing demand as well as a large excess in supply, with China’s recent announcement of an industrial slowing and oil flooding the market. Although only forming about 25% of the Brazilian benchmark, this understates the importance of fiscal redistribution from these assets. As a significant part of the Brazilian government agenda, falling prices will weaken their ability to stimulate. The alternative is to raise taxes but this would simply choke off profitability for large portions of the market.
Big Government….little reform
The Brazilian government has been notorious for under-investing in the economy. Spending has mostly been to social welfare, fuelling consumption, and stifling productivity gains. This has rendered Brazil uncompetitive as a manufacturer, and meaningful devaluation of the Real is required.
There is a long list of problems that this government must address, including the bureaucracy associated with foreign direct investment, as well as simplifying the complicated tax structure. According to the World Bank, Brazil is ranked a lowly 120th in the world for countries in their ‘ease of doing business’ index. This places them behind countries such as Egypt, Jordan and even Swaziland. Hopes that the plethora of problems that have stifled this nation, so blessed with resource, could be resolved by a more favourable outcome at the very recent election have also been dashed. Suggestions that the latest appointment of, Chicago University educated, Joaquim Levy to Finance Minister signals a turnaround, are hopelessly optimistic. President Rousseff was not elected on a campaign of reform and this government will not make the difficult decisions Brazil so desperately needs.
Valuations
As is the case with many emerging markets, aggregate valuations are dragged down by the large and inefficient State Owned (influenced) Enterprises such as Vale and Petrobras. The outlook for these companies is poor and their lowly valuations are well merited. Away from these companies and the financial sector, the index is not particularly cheap. Brazil, therefore, is a classic value trap.
Where to invest?
India
We have a positive outlook for the Indian market, given the ambitious reform programme the country is embarking on. It was not so long ago that India was lumped together with Brazil and others under the moniker the ‘fragile five’. What’s changed since then to make us so positive? Well, in short, a lot!
The decisive election victory of Narendra Modi in May this year was an important turning point, but it is not only Modi that is working to revive the economy. Raghuram Rajan, the Central Bank Governor of the RBI, is a star that shines even brighter than our own. Together, and along with a considerable slice of luck in the form of lower commodity prices, they are tackling the main issues; inflation, current account and fiscal account.
Inflation
Raghuram Rajan has proven extremely vigilant to the threat of inflation, having increased the key interest rate by 75 basis points over his tenure. Wholesale price inflation fell to a five year low in October possibly even giving scope for the naturally hawkish central bank to cut rates and provide a boost to economic growth.
Current Account
The current account deficit has also improved dramatically since last year, largely helped by weakness in the commodity markets, particularly gold and oil. Some commentators have suggested the current account may swing into surplus next year. We would have some caution; we do not believe oil prices at these levels are sustainable, restrictions on Gold imports have recently been removed and we expect growth to pick up which will naturally cause increased demand for imports. However, whether it moves into positive territory or not, the current account is no longer a significant source of worry and should result in a more stable currency.
Fiscal account
There has also been a dramatic improvement in the fiscal account. With the fall in oil price, the government announcing the sale of stakes in a number of state owned companies and the increase in growth will improve tax revenues.
Long term equity gains
The stabilisation of these three factors provides a solid footing for the economy, allowing Modi to target investment, and ultimately growth, with future reforms. With such a structural tailwind in place of genuine reform, India’s potential growth rate must rise. Given this, we believe the moderate premium currently afforded the market is justified. Indeed in conversations with Nouriel Roubini just recently, it was proclaimed that India would be growing faster than China in 2016.
We have long derided the ‘supposed’ correlation between economic growth and stock market returns. However, when you observe above trend growth, and it is combined with government and monetary policy that renders such growth as sustainable, we believe this is a powerful cocktail for long term equity gains.
ENDS
The value of investments can fall and you may get back less than you invested.
No investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us.
Past performance is not a guide to future performance.
The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents.