A 10X story unfolding in Brazil? … the agony and ecstasy of investing in a commodity-driven economy … comparing Brazil’s valuation to that of the U.S.
Imagine a stock index skyrocketing more than 1,000% in six years.Not a single stock – an entire index. It’s an extreme rarity, but it’s happened before… During Luiz Inácio Lula da Silva’s first six years in office, Brazil’s Ibovespa Stock Index skyrocketed a jaw-dropping 1,210% in U.S. dollar terms. Now, this is great for Brazilian investors who took advantage of this back when it happened, but what’s the relevance to you? After all, if you’re like me, you’ve been laser-focused on the Fed, inflation data, oil prices and the rest of our domestic drama. Why are we discussing Brazil? Because earlier this week, the Brazilian people re-elected Lula. And our macro expert Eric Fry believes this is just one more reason why you should strongly consider investing there today. To be clear, Lula is just icing on the cake. The bigger Brazilian investment story has to do with boom/bust commodity cycles and de-globalization. Put it all together, and here’s Eric’s top-line summary:
I see an emerging opportunity that is still completely off the radar of most investors.And if history repeats itself, as it so often does, most investors will miss this opportunity just as they missed the last one. In fact, if past is prologue, an upcoming event could well signal a new “golden age” for these stocks…
Let’s jump in.
The agony and ecstasy of investing in Brazil
For newer Digest readers, Eric approaches the markets with a “top down” perspective. In Investment Report, he identifies the massive political, social, and economic currents that are shaping global markets. After pinpointing the most attractive countries and sectors based on this analysis, he digs deeper, finding the best specific investments that are poised to capitalize on those macro trends. It’s an effective approach, to say the least. Eric has found more 1,000%+ recommendations than anyone we know of in the newsletter business – 40. Most investors are lucky to get one such 1,000%-gainer. As we just noted, Brazil turned into a 10-bagger for investors who took the plunge back in 2003. Could it happen again? In answering that, let’s begin by better understanding why it happened the first time. Here’s Eric:
[Lula] took office just as a powerful commodity super-cycle was about to shower prosperity on Brazil’s resource-focused economy.From 2003 to 2011, Brazil’s GDP quintupled – from $500 billion to $2.6 trillion. The unemployment rate tumbled from a high of 13% in 2003 to less than 5% a few years later.
Meanwhile, what was happening with Brazil’s stock market leading into Lula’s election and this period of hypergrowth?Eric explains that the Ibovespa tumbled more than 60% during the months leading up to the election. It’s this divergence that created the spectacular Brazilian buying opportunity. You already know the outcome – 10X gains.
But economies that live by commodities also die by commodities
That’s the danger of investing in an economy driven by boom/bust cycles. If you don’t time your investment skillfully, the portfolio damage can be extraordinary.Back to Eric:
But then 2011 arrived, and the feijoada hit the fan.The commodity boom turned to bust. Prices slumped for a decade, culminating in the pandemic crash of March 2020. As commodity prices imploded, so did the Brazilian economy. GDP growth tumbled from a robust annual rate of 9% in 2010 to negative 10.7% in 2020! During that “lost decade,” almost everything that could go wrong in Brazil did go wrong. As a result of relentless economic and political trauma that pummeled the economy from 2011 to 2020, Brazil’s stock market tumbled to a nearly 15-year low in March 2020.
So, where is Brazil today as viewed through its boom/bust economic lens?Eric explains that from 2020’s economic low-point, Brazil’s economy has been on the mend. Its GDP has regained its pre-COVID levels, and unemployment has dropped to its lowest reading in six years. Behind this growth is the long-awaited positive upturn in the commodity sector. Back to Eric:
…Thanks to the new commodity supercycle that launched in 2020 – history repeating itself – Brazil is in a macroeconomic sweet spot once again.And yet, investors have been slow to reward the Brazilian stock market accordingly… just like two decades ago.
But what about the potential for a global recession? Can Brazil continue growing?
According to Eric, there are two tailwinds for Brazil’s economy today:The first is the boom/bust commodity cycle we’ve discussed:
Although Brazil boasts an increasingly diversified economy, the country’s prosperity still relies heavily on natural resources like energy, agriculture, and mining.In other words, what’s good for the commodity-price goose is great for the Brazilian-economy gander. And as you know, commodity prices have moved higher this year, which is unalloyed good news for the Brazilian economy and stock market.
The second tailwind is the growing trend of de-globalization.Eric sees Brazil as one of the primary beneficiaries of the mass exodus by Western companies from Russia. This is a seismic economic event that will redirect investment flows and reshape global supply chains for years to come. To get a sense of how impactful this could be, let’s rewind to how the Brazilian economy benefited from U.S.-Sino trade war. After President Trump started slapping tariffs on a variety of Chinese imports, many Chinese importers shifted a significant portion of their supply chains from U.S. producers to Brazilian producers. What was the economic impact? This past June, Brazil’s total export volumes hit a new monthly record of $32.7 billion. Meanwhile, the country’s annual export volume has risen to $310 billion, also a new record.
One final reason to look at Brazil
To explain this benefit, let’s begin by looking here at home.For as much as the U.S. stock market has sold off this year, its valuation remains quite high by at least one metric – the cyclically-adjusted price-to-earnings ratio (CAPE). The difference between a regular price-to-earnings ratio and the CAPE ratio is that CAPE uses earnings stretched over a 10-year period. This is done to smooth out business-cycle fluctuations. Even after the yearlong stock market pain, today’s CAPE ratio remains among the most expensive readings over the last 140 years. Its reading of 27.54 is miles above the long-term average of 17.
Now, does this elevated CAPE really matter? And what good is it practically speaking if it uses 10-year-old data?Well, it’s a very blunt valuation tool. So, it’s not good for market timing. But that doesn’t mean it’s not a powerful indicator that can be immensely valuable for long-term investors. To illustrate, below is a chart from my friend and popular quant-investor, Meb Faber. Starting in 1900, the chart shows initial CAPE values of the S&P 500 and what the ensuing S&P 10-year returns were based on those starting CAPE values. Dark green represents the cheapest CAPE starting years. Red represents the most expensive. As you’ll see visually, most of the “green” starting years (low CAPE ratios) end up on the right side of the chart – meaning big, double-digit 10-year returns. On the flip side, “red” starting years (high CAPE ratios) usually end up on the left side of the chart – meaning low and negative 10-year returns.
Now, remember, today’s CAPE ratio is at 27.54. The “red” category covers values from “20 to 45.”That means today’s level is deep in this “red” starting-year bucket.
With this context, let’s now pivot back to Brazil
What is its CAPE ratio?Eric’s research in Investment Report suggests that same outcome could be setting up again right now. Have a good evening, Jeff RemsburgMeb just updated the numbers a few weeks ago… It’s 13. That places it in the “light green” starting-year bucket. Which valuation – and by extension, which forward-looking potential return – is more attractive to you? Bottom line: If history is our guide, Brazil is looking awfully good as an investment today. In fact, Eric has a Brazil pick in his Investment Report portfolio that’s up 13% since the summer. Twenty years ago, investors who saw the opportunity enjoyed 10X growth. As we stand today,