Largely unnoticed thus far, Brazil's Bovespa index has fallen to levels not seen since May of 2009. It is the objective of this post to explain why this may constitute the world's largest sell signal.
Brazil should be on your radar as an important macro leading indicator for many reasons. It is the world's 7th largest economy by nominal GDP and the 8th largest by purchasing power parity. It is 10th in the world in total railways, 4th in total roadways, and 3rd in total waterways, and 2nd in total airports.
Brazil is home to over 200 million people and has a large and stable middle class. Its labor force is the world's 6th largest. It is 6th in the world for total main line telephones in use, 5th in total mobile phones, 5th in total internet hosts, and 4th in total internet users in the world.
Slightly smaller than the US, Brazil has the 5th largest total land mass in the world. It is the largest country in South America, and shares common boundaries with every South American country except Chile and Ecuador. Characterized by large and well-developed agricultural, mining, manufacturing, and service sectors, Brazil's economy outweighs that of all other South American countries.
According to the World Economic Forum, Brazil was the top country in upward evolution of competitiveness in 2009, gaining eight positions among other countries, overcoming Russia for the first time, and partially closing the competitiveness gap with India and China among the BRIC economies.
In 2008, Brazil became a net external creditor and two ratings agencies awarded investment grade status to its debt. After record growth in 2007 and 2008, the onset of the global financial crisis hit Brazil in September 2008.
Brazil experienced two quarters of recession, as global demand for Brazil's commodity-based exports dwindled and external credit dried up. However, Brazil was one of the first emerging markets to begin a recovery. Drawing on vast natural resources and a large labor pool, it is today South America's leading economic power and a regional leader.
Consumer and investor confidence revived and GDP growth returned to positive in 2010, boosted by an export recovery. Brazil's strong growth and high interest rates make it an attractive destination for foreign investors. Large capital inflows over the past year have contributed to the rapid appreciation of its currency and led the government to raise taxes on some foreign investments. President Dilma Rousseff has pledged to retain the previous administration's commitment to inflation targeting by the Central Bank, a floating exchange rate, and fiscal restraint.
Brazil is a mostly tropical climate with few natural hazards other than recurring droughts in northeast, and floods and occasional frost in south. It has abundant supplies of fresh water. It is not on any major fault lines, and both earthquakes and hurricanes are rare.
It is rich in a variety of natural resources such as bauxite, gold, iron ore, manganese, nickel, phosphates, platinum, tin, rare earth elements, uranium, petroleum, hydropower, and timber.
A pioneer and leader in the manufacture of short-fiber timber cellulose, Brazil has also achieved positive results within the packaging sector, in which it is the 5th largest world producer. In the foreign markets, it answers for 25 percent of global exports of raw cane and refined sugar; it is the world leader in soybean exports and is responsible for 80 percent of the planet's orange juice, and since 2003, has had the highest sales figures for beef and chicken, among the countries that deal in this sector. Brazil has the largest cattle herd in the world, with 198 million heads.
Brazil became energy independent in 2006. Brazil is one of the world's leading producers of hydroelectric power, with a current capacity of about 260,000 megawatts. Existing hydroelectric power provides 90 percent of the nation's electricity.
The government also plans to have a total of 21 nuclear plants by the year 2020.
Brazil's industries account for 28.5 percent of GDP, and range from automobiles, steel and petrochemicals to computers, aircraft, and consumer durables.
The country's principle exports are commodities such as transport equipment, iron ore, soybeans, footwear, coffee, autos.
These and many more are reasons why I count myself as a long-term Brazil bull over the course of the next 25-30 years. But it is also here that my analysis sees a red flag for the medium term.
In the Far East, there is an equally large and prosperous country that is very fond of iron ore. This booming country is also seen as a macro leading indicator. It is even widely supposed that this county's growth alone will pull the rest of the world out of its doldrums, and that it's growing so fast that all the world's iron ore can barely keep up with its insatiable demand.
The other side of this argument is that the iron ore is in fact used for the construction of entire cities that have virtually no one living in them. There's Ordos, Inner Mongolia. Erenhot, Xilin Gol, also in Inner Mongolia. Zhengzhou New District in Henan. And Xinyang, also in Henan. There's even the the largest mall in the world in Dongguan, which has been 99% vacant since its 2005 opening.
The country is China, and it is Brazil's largest export partner.
In that iron ore represented 43% of Brazil’s exports to China in 2010, a sudden reduction in the demand for new cities might show an immediate effect on Brazil's economic barometer, the Bovespa index.
There is no other major stock index in the world that has yet demonstrated this price action. From a technical analysis standpoint, the uptrend began in 2008. It never made a new low in 2009 as nearly every other global index did, thus it acted as a leading indicator. Note also that the uptrend from the 2008 lows was broken in 2010. The warning light began flashing.
Currently, having retraced all the way back to, and even piercing, the May 2009 lows, the Bovespa is screaming for our attention.
There is another chart that demands our attention. The Chinese state company Sinopec was the largest buyer of Brazilian oil, importing 200,000 barrels per day, in 2010. What does its chart look like?
It too is flashing red. In fact, some of the largest stocks listed on the Bovespa with exposure to China have similar charts as well.
Petroleo Brasileiro (Petrobras) -- Oil & Gas Producer
Gerdau -- Metals & Mining
Embraer -- Aerospace & Defense (Commercial aircraft)
Companhia Siderurgica Nacional -- Metals & Mining
Obviously there is something about 2009 that we're supposed to wrap our heads around. I also suspect these charts are suggesting that China's game of GDP juicing is just about over.
And so as not to play favorites, who is Brazil's 2nd largest export partner? It's the United States of America. We're not looking very juicy lately, either.
I came across an interesting mention of the Brazil/China dynamic in China: Brazil's Largest Export Market.
Brazilian exports to China have been increasing and improving since 1993. Different from financial channels, that are extremely volatile, trade channels are more stable. Therefore, the linkages between Brazil and China seem to be growing in times of world crisis. This suggests that Brazil will benefit from China´s windfall and might even use China´s resources to shield from the world financial crisis.
In reading this paragraph, I wish to draw your attention to this line: Brazil will benefit from China´s windfall and might even use China´s resources to shield from the world financial crisis.
I strongly disagree.
From the previously cited stats, note that "Brazil experienced two quarters of recession, as global demand for Brazil's commodity-based exports dwindled and external credit dried up. However, Brazil was one of the first emerging markets to begin a recovery."
1) . . . as global demand for Brazil's commodity-based exports dwindled and external credit dried up -- Realize that global demand for commodities ebbs and flows with liquidity which further ebbs and flows with the amount of credit in the global financial system. We are currently very close to outright credit contraction. The debt markets are demonstrating that cash is not being put to work; it is being hoarded.
2) . . . Brazil was one of the first emerging markets to begin a recovery -- The first market to begin a recovery is often first to signal a contraction.
I think this is exactly what the Bovespa is doing. It is giving us advance warning that other global stock market indices, particularly the Dow and the S&P 500, are on their way back not just to May 2009 levels, but while they're at it, the March 2009 levels would likely make an excellent target as well.
Then the Devil may get his due, on the S&P at least, back down there at 666.
There will come a time after the credit contraction that I will be very bullish on Brazil. Until such time, and because I find the timing amusing, I'd like to draw your attention to the good people at Morgan Stanley. I noticed this headline today Morgan Stanley Raises Emerging-Market Equity Allocation and had a chuckle.
Aug. 15 (Bloomberg) -- Morgan Stanley raised its allocation to emerging-market equities to the highest level since April 2009, citing “historic” low valuations and prospects the stocks will outperform developed nations’ shares.
Back in 2007-2008, as if it were a test of mettle, I kept bumping into an acquaintance of mine who was a financial advisor at Morgan Stanley. He was incredibly bullish while I was carrying the largest short line I'd ever had. He kept trying to get me to read a big MS report on Brazil. Basically going long Brazil was a sure thing, he kept saying.
Well, Brazil cratered in the financial crisis just like every other country. The last time I saw him he said he was going to do "one of your kind of trades" -- he wanted to short oil. It was about 40 at the time.
I must say that I like the timing of this Morgan Stanley call.
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Sources for the statistics cited in this post were taken from the CIA World Factbook and the Economy Of Brazil/wiki