Now is a Great Time to Invest in this Emerging Powerhouse

David Sterman's picture

Monday, August 15, 2011 - 1:30pm

by David Sterman

Even as the market surged ever higher in 2009, 2010 and early 2011, an unpleasant development occurred. One of the world's most appealing economies saw its stock market zoom ahead so quickly, that it became hard to justify putting any new investment dollars into it. But thanks to the recent global market rout, this has changed. Brazil, which has been laying a foundation to become one of the dominant economies in the world, has seen its stock market fall sharply in recent weeks and is now back to levels seen in 2007, making now a good time to invest in this promising market.

I recently took a quick look at projected global growth rates for our sister site, InvestingAnswers.com and found Brazil is poised to become the fourth-largest economy in the world by 2040, surpassing once-mighty Japan, France and even the United Kingdom. All of these countries currently sport larger economies, but face huge long-term headwinds, while Brazil stands to reap the benefits of the many tailwinds at its back.  Here are four reasons in particular to be so bullish about Brazil's economy.

1.  Abundant natural resources
Brazil has always been blessed with ideal climate for farming, making it a leading exporter of commodities such as cattle, sugar cane, soybeans, coffee. Brazilian agricultural firms have made huge investments in technology to ensure their sprawling plants operate highly efficiently.

Along with Argentina, Brazil stands to serve as the breadbasket for all of Latin America, as the region becomes host to rising middle classes, which are avid to consume higher quantities of protein and more diverse types of vegetables. This agricultural boom has been strongly supported by the country's oil boom, in which Petrobras (NYSE: PBR), Brazil's largest oil firm, is the star. The federal energy giant has poured billions into massive offshore oil fields and the benefits are just now starting to flow. Brazilian oil exports should greatly strengthen the country's finances, as has been the case in Norway and Saudi Arabia, each of which have been able to make considerable investments in their economies thanks to petro-dollars.

2.  The virtuous cycle of a rising middle class

In the past decade, many Brazilians have moved up from poverty to lower middle-income status. If history is any guide, this move up to the lower middle-income strata sets the stage for a full-fledged boom into the heart of the middle class. This is because consumer spending starts to rise on a range of new items such as jewelry, appliances, travel and even investments. This helps spur even more job creation in the industries that see rising demand, and many of those jobs are managerial. Just as in the United States we used to boast "I was the first person in my family to go to college and buy a home," an increasing number of Brazilians are set to make the same claim.

3. Rising investments in infrastructure
Brazil's infrastructure has been sorely lacking, making it very hard to get perishable goods from the heartland to the shipping ports. Government is belatedly tackling the bottleneck by building or upgrading many roads, bridges, inland ports and airports. Recall what the advent of the Interstate Highway system did for the United States in the second half of the 20th century. Brazil is set to reap the same benefits.

4. Reaping the peace dividend
It's impossible to understate the peace dividend taking place in Latin America. Brazil and its peers have historically suffered from dictators, civil wars and border wars. Not anymore. Human rights remain a challenge in places such as Venezuela, Cuba and Guatemala, but for the most part, the political class in Latin America has made major strides in fiscal and judicial transparency, a balanced approach of the interests of the elite and the broader population, and stepped up investments in education and training.

With all these positives, there must be a reason why Brazilian stocks are slumping. The iShares MSCI Brazil Index fund (NYSE: EWZ) has fallen from $80 this spring to a recent $60. Some of the blame goes to the global stock market selloff, of course. But Brazil also has its share of near-term headwinds, most notably a too-strong currency and perhaps a too-active banking sector.

Brazil's currency, the real, surged from $0.45 to the real in 2006 to $0.65 in 2008, making its exports less competitive on global markets. The real subsequently plunged back to $0.45 in the global economic crisis of 2008, and it is now back up to $0.62. A strong currency is the unfortunate byproduct of countries with a huge commodity export sector. While an abundance of natural resources has allowed companies like Vale (NYSE: VALE) to recently become the largest mining company in the world, it also leads to what's known as the "Natural Resources Curse." The only way to tackle this problem is to turn trade surpluses around by encouraging more imports. Brazil currently favors its native industries and companies at the expense of foreign rivals with a wide range of tariffs, a policy that should be reversed. (Memo to President Obama, visit Brazil repeatedly to make a stronger case for U.S. exports into Brazil.)

Concerns about the banking sector -- which always has the potential to end badly if banks end up holding too many bad loans -- appear to be overblown. Brazilian banks are far stronger than most may think. Global banking regulators require banks to hold at least 8% of their capital aside (known as Tier 1) in case they get hit with a large amount of loan defaults. But according to the Brazilian central bank, this figure stood at 16.9% at the end of 2010 (above the Brazilian mandated minimum of 11%). Goldman Sachs recently assessed the Brazilian banking sector and found the "Brazilian financial system is robust enough to withstand moderate to strong negative shocks."

Even as Brazilian lending has risen at a fast clip in the past six years, it is still fairly low relative to the size of the economy, thanks to a very low base when the lending boom began six months ago. "The degree of leverage in Brazil remains relatively small for international standards, in part because the financial deepening process is recent. In fact, the leverage ratio in Brazil is only 9.6%, compared with 10.3% in Mexico, 17.5% in Canada and 20% in Australia," note Goldman's analysts. This is not to say that Brazil wouldn't feel the negative effects of a major global economic downturn -- just not to the extent that the media is warning.

There are other reasons for optimism. For instance, companies like Vale still manage to post solid growth, even after all the recent market turmoil. Petrochemical company Braskem (NYSE: BAK) has been acquiring smaller players in the sector (it just bought Dow Chemical's polypropylene business, making it the largest producer in the United States). And in three years Brazil will host the Olympic Games and the World cup, which has boosted construction and has already made the tourism industry boom.

Action to Take --> Take advantage of these short-term concerns because they should have little impact on Brazil's impressive long-term trajectory. The Brazilian market may not have hit bottom, so be prepared for any further weakness. But in the context of the long-term, this sell-off creates a great opportunity for value investors who want to venture in this booming emerging market.

The One Stock to Buy BEFORE President Obama's Emergency Briefing
A little-known event is about to take place that could be catastrophic to the United States. You're not hearing about it on CNN or Fox News (yet)... but you will. Don't be surprised if there's a briefing from the president himself. The governments of China, India and Russia are all involved... and an estimated 31 million Americans will be impacted. StreetAuthority's top research analyst has put together his own "emergency briefing" that spells out step-by-step what's going on. He's also identified the one stock he predicts could double in a hurry as this situation unravels. Click here to watch the briefing.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.