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History of the Ipanema de Moreira Family

There are two streets in Rio de Janeiro that commemorate the passage of Jose Antonio Moreira. One is the Rua Barao de Ipanema in the neighborhood of Copacabana Beach and the other the Rua Conde de Ipanema in the adjacent Ipanema Beach. Not much has been written about this influential Brazilian entrepreneur and financier of the Portuguese colony under Dom Joao VI and of the empire under Pedro I and Pedro II. Since he happens to be my ancestor, I have  put together a short and sketchy biography which relies on public documents and family archives. His story reflects the modernization of Brazil in the 19^th century – from a slavery-manned plantation economy to a modern industrializing nation. It is also a tale of poor timing in real estate speculation and the dissipation of wealth by idle descendants.

The trail of the Ipanema de Moreira family starts in the city of Sao Paulo, Brazil in the late 18^th century.  Jose Antonio Moreira, the future Count of Ipanema, was born in Sao Paulo, October 23, 1797, the son of Jose Antonio Moreira (Father) and Ana Joaquina de Jesus. The family was of noble origin, from the Braga District of northern Portugal. Moreira is a common name in Portugal, meaning mulberry tree, sometimes associated with the community of “conversos.” (Forced conversion of Jews to the Catholic faith)

Jose Antonio Moreira (father) was a prosperous merchant in Sao Paulo with close links to the colonial administration.  He had a key role in developing Brazil’s first modern industrial enterprise, the Ipanema iron works (Fundicao Ipanema).

Napoleon’s invasion of Portugal caused the Portuguese court of Dom Joao VI to flee to Rio de Janeiro in 1808. Dom Joao VI immediately eliminated all existing mercantilist restrictions on domestic manufacturing and actively supported industrial self-sufficiency. Iron smelting was considered a high priority and an area of with iron deposits in the vicinity of the city of Sao Paulo was chosen as a site for development.

The existence of iron ore deposits on the Ipanema Hills in an area known as the Fazenda Ipanema, nearby the village of Iperó, 125 km northwest of the city of Sao Paulo, had been known since the early days of the Portuguese colony. The site chosen for the iron smelter was located on the Ipanema River, a tributary of the Sorocaba River, and was surrounded by forests which could be used as fuel for smelting. The area had previously been inhabited by Tupi Indians, who had named it “Ipanema,” a reference to a river that has its source there. Ipanema means “stagnant or barren water” in Tupi-Guarani.

The company was established by Royal Charter in December 4, 1810 as a mixed capital shareholder company, with 13 shares belonging to the Portuguese Crown and 47 to private shareholders, businessmen with connections to the court. Jose Antonio probably represented the crown’s interests and was a founding investor. The project was of keen interest to Dom Joao IV who enlisted technical support from Swedish and German specialists, and he is s known to have visited the mill on multiple occasions.

The Fazenda Ipanema Ironworks, known as the Real Fábrica de Ferro de São João de Ipanema, smelted its first iron in 1816 and operated until 1895.  A picture from 1890 is shown below.

The enterprise, which can be considered Brazil’s first modern industrial undertaking, included a dam and a 4-km railroad connecting the iron ore deposits with the plant. The area is now a national park and a popular tourist attraction. The structures of the mill are intact, as shown in the pictures below, and can be visited by the public.

The geographical location of the site is shown in the maps below.

Jose Antonio Moreira, both father and son, were actively involved with the Fundicao Ipanema.  The future Count of Ipanema, who will be referred to as Jose Antonio Moreira from now on, was involved with the Ipanema Fundicao from an early age, and he would remain connected to industrial ventures in metallurgy and metal-working in Brazil’s first wave of industrialization during the imperial regime.

From the time of the Fundicao Ipanema, the Moreira family remained closely tied to the imperial court in Rio de Janeiro. By the early 1820s, Jose Antonio Moreira had settled in Rio De Janeiro where in 1823 he married Laurinda Rosa Ferreira dos Santos, the daughter of a Portuguese merchant from Porto.   She was born in Rio de Janeiro in 1808 and died in Brussels in 1881. They has six children: José Antonio Moreira Filho, the future 2 º Barão de Ipanema (1830-1899); João Antonio Moreira (1831-1900); Joaquim José Moreira (1832-?); Manoel Antônio Moreira (1833-?); Laurinda Rosa Moreira (1837-1920); Mariana Rosa Moreira (1842-?) and Francisco Antônio Moreira (1845-1930). (Francisco Antonio Moreira was my great-great-grandfather.)

Jose Antonio married into one of imperial Rio de Janeiro’s wealthiest families. His father-in-law was Jose Ferreira dos Santos, a highly prominent merchant. Recent research by UCLA history professor William Summerhill reveals that Jose Ferreira Dos Santos was a member of the Junta Administrativa da Caixa de Amortizacao from 1840-46. The members of this parliamentary commission — “national capitalists…and the largest holders of the national debt”  — oversaw the Treasury’s operations to ensure payment of sovereign debt obligations. Jose Antonio himself was to sit on this commission from 1959-1969. During this extended period of prosperity under Emperor Pedro II, both Jose Antonio and his father-in-law were among the largest holders of government bonds, so-called “apolices,” in what was a highly concentrated market. (Summerhill provides a fascinating account of the Empire’s finances in his book Inglorious Revolution. This extended period is unique in Brazilian history for the impeccable creditworthiness of the Brazilian state.)

Jose Antonio’s success as an entrepreneur and financier and his  service to the Imperial Court was recognized on numerous occasions with the highest honors:  Comendador da Imperial Ordem de Cristo and Dignitário da Imperial Ordem da Rosa (Commander of the Order of Christ and Officer of the Imperial Order of the Rose), 1845; Baronato  de Ipanema (Barony), 1847;  Grandezas de Barão de Ipanema (Barony Grandee), 1849; Viscondado com Grandeza  de Ipanema (Viscount Grandee), 1854; and Conde de Ipanema, 1868 (Count).  Jose Antonio’s association with the Ipanema Iron Works and metallurgy are made clear by the choice of the Ipanema name.  (Imperial titles of nobility were awarded on the basis of merit and service to the crown and, generally, were not hereditary.)

The heraldic shields of both the Portuguese Moreiras and the Brazilian Ipanemas are shown below. Notice that both shields have the flourished cross, which in Portugal was the symbol of the Knights of Saint Benedict of Aviz, an order of chivalry founded in 1146. The Ipanema shield also has a blue line with five stars (representing the Ipanema River) and a Caduceu of Hermes (wisdom).

 

In 1844, during the reign of Pedro II (1831-89), Brazil adopted policies to promote industrialization and the import-substitution of manufactured goods , including stiff tariffs of up to 60% on imports.  Prior to this reform, the country had relied extensively on British imports. The policy shift resulted in Brazil’s first wave of industrialization, which had as its leading entrepreneur Irineu Evangelista de Sousa (Visconde de Maua). Jose Antonio Moreira was an early investment partner and adviser to the Visconde de Maua.  It is clear that Jose Antonio put his court connections and expertise in metallurgy to good use over this period, and he coinvested with the Visconde de Maua in steel, shipyard, banking, steamboat and railroad ventures.

Jose Antonio Moreira was the first president of the Banco do Brasil, a Visconde de Maua venture that was crucially important in financing Brazil’s early industrialization and still plays a vital role in Brazil’s economy today.

Interestingly, in the Banco do Brasil’s founding charter documents Jose Antonio is described as a “national businessman involved in the business of ships and national goods” (comercio de navios e generos nacionais).

Jose Antonio also had business partnerships with foreign investors, including steel concerns in Belgium. From the mid-1850s Jose Antonio is connected to Brussels, and in 1860 his wife, Laurinda Rosa Ferreira dos Santos, takes up residence there. From this time, four of their six children are established in Brussels: Manoel Antonio, Marriana-Rosa, Laurinda Rosa and Francisco Antonio Moreira. Manoel remained in Brussels where he served a Brazil’s general consul, and his son, Alfredo de Barros Moreira, would serve as Brazil’s first ambassador to Belgium.

We have two portraits of Jose Antonio. The first is a sketch of him as a young man; the second, dating from the 1860s, shows him in his prime.

It was during the final phase of his life in the 1870s that Jose Antonio Moreira purchased an estate located some 12 km south of the center of the city of Rio de Janeiro. This area with more than 3 km of beaches facing the Atlantic is now known as the Ipanema Beach neighborhood.

The estate was purchased in 1878 and initially it was used as a country house (chacara). An artistic rendition of what the area may have looked like in the 1870s by the painter Eduardo Camoes  (b. 1955- ) is shown below.

The map below shows the estate in the context of today’s Rio de Janeiro. The “chacara” extended from  the southern tip of Copacabana Beach (delineated by the current Rua Barao de Ipanema) to the canal that connects the ocean with the Rodrigo das Freitas Lagoon and creates the division between the neighborhoods of Ipanema and Leblon. The property stretched into parts of modern-day Leblon, including the current site of the Monte-Libano sports club.

 

The land purchased by Jose Antonio Moreira was known at the time as “Praia de Fora de Copacabana,” which was part of a larger area called the “Fazenda Copacabana.” Most of the property was purchased from Charles Le Blond, a French entrepreneur who ran a whaling operation called “Alianca´ and had secured a monopoly on supplying Rio de Janeiro with whale oil. Le Blond went out of business in the 1860s when the Visconde de Maua introduced gas lighting to the city of Rio de Janeiro, and this may have provoked the sale of the property.  Vestiges of Le Blond’s whaling operation include the names of the Leblon Beach neighborhood as well as Arpoador  (Harpooner) Beach at the easternmost point of  Praia de Fora. The rocky promontory which separates Arpoador Beach from Copacabana  played an important part in the whaling operation as an ideal lookout to detect migrating pods of whales.

The area was originally occupied by Tamoia Indians, and, briefly, in the 1550s it was the site of a French military outpost. Reportedly, an early Portuguese governor eradicated the Indian population by furnishing them with blankets infected with smallpox (apparently a common practice in the 16^th century).

The southern and western parts of the “Fazenda Copacabana” also were widely used for large sugar cane milling operations and cattle grazing from the 16^th to the 19^th centuries in the area which stretches from Leblon to the Jardim Botanico. The eastern part of the Fazenda Copacabana (modern day Copacabana and Ipanema) were inappropriate for farming because of sandy, acidic soil (restinga) and, in the case of Ipanema, frequent flooding from the lagoon.  One of the few structures in the area was the Igreja of Nossa Senhora de Copacabana, a Carmelite hermitage founded in the early 16^th century. The hermitage had a copy of a statue of the Virgin Mary from the Church of Nossa Senora de Copacabana on the shores of Lake Titicaca in Peru which was said to have miraculous qualities, and that is the source of the name of the beach.

In all likelihood, the purchase of the Praia de Fora estate was made as a farsighted speculative real estate bet. As a prominent businessman with close ties to the Viscount of Maua and the imperial administration, the Count of Ipanema knew the city’s plans for urban development. Central to this vision was the Companhia Ferro-Carril Jardim Botanico, a Viscount of Maua venture, that was planning to expand its tramway coverage to the southern beaches of Rio de Janeiro. Moreover, he was certainly aware of the mid-19^th century European boom in beach resorts made possible by railroads and by a newfound appreciation for the health benefits of the sea. Unfortunately, the Count passed away in 1879, leaving the future development of the area in the hands of his eldest son.

 

Jose Antonio Moreira Filho was 49 years old when his father passed away.  He appears to have been a successful businessman in his own right and highly regarded by the Imperial Court, and he was decorated on several occasions:  Commander of the Military Order of Christ and  the  Order of Our Lady of the Conception of Vila Vicosa (the paramount award given by the sovereign for services rendered to the Royal House). He received his baronage by decree in 1885, and the grandeeship by decree in 1888. In 1856 he married Luiza Rudge (1838-1891), daughter of George Rudge and Sofia Maxwell.  His father-in-law was Joseph Maxwell (1772-1854), one of Brazil’s richest men, founder of the Maxwell Wright commission house. This was a trading house with strong links to the American and British markets which was a leading participant in the coffee export boom and a facilitator of the Atlantic triangle trade (imports of grains and manufactured goods from America, exports of coffee and slave trading with Africa). The Rudges were business partners with Joseph Maxwell. Both the  Rudge and Maxwell families were originally merchants from Gloucester, England. Jose Antonio Filho and Luiza Rudge had five children — Carlos, Luiza Sophia, Jose Jorge, Carlos Alfredo, Laurin Rosa  and Sophia, Emilia – all of whom assumed the surname Ipanema de Moreira and lived their lives in Rio de Janeiro.

The only portrait we have of Jose Antonio Filho is the one shown below, made in the 1870s before he had become the Baron of Ipanema.

We also have a painting of the two eldest children Carlos and Luiza posing in a hamac in Ipanema with the  Rodrigo da Freitas Lagoon and the Catacumba Peak in the background.

Jose Antonio Moreira Filho’s plans for “Praia de Fora” depended on improved access to the southern beaches. During the 1880s the estate had been accessed primarily from the sea by occasional tourists. This changed when in 1892 the Companhia Ferro-Carril Jardim Botanico inaugurated the Copacabana Tunnel (today known as Alaor Prata), linking Botafogo Beach with Copacabana Beach, and providing tram service between the center of Rio and the southern beaches. A tram line covering the entire extension of Copacabana beach was completed by early 1894.

In anticipation of the further extension of the tram service, in April 1894 the Vila Ipanema real estate development project was officially launched. The land holdings owned in Copacabana and Leblon were not included in Vila Ipanema, and may have been donated to the city or incorporated into other developments being actively promoted at the time.

The layout of the Vila Ipanema can be seen in the two documents below. The first, dating from 1894, is the original urban design commissioned to Luiz Rafael Vieira Souto who was the Chief Engineer of the Municipality of Rio de Janeiro.  The second, dating from 1919, is from a marketing brochure.

Vila Ipanema divided the area into 45 blocks.  The standard block was broken into 40 lots, each measuring 10 meters by 50 meters. More than a million m2 of real estate were put on the market.

The initial launch included 19 streets and two public squares (General Osorio and Nossa Senhora da Paz). Most of the street names honored family members, associates and political allies of the Baron and his partners. For example, the main road at the time of launch was the Rua 20 de Novembro (Visconde de Piraja), which commemorated the date of birth of Luisa Rudge. Of the original names few remain: Alberto Campos (brother in law) remains; Avenida Vieira Souto, in honor of the urban planner, still graces the waterfront.

Jose Antonio Moreira Filho had several partners in Vila Ipanema: Coronel Antonio Jose Silva, Jose Luis Guimaraes Caipora and Constante Ramos.  The Coronel incorporated land he owned in Praia de Fora into the Vila Ipanema project. In 1901 the shareholders of Vila Ipanema were:  Ipanema de Moreira family, 90%; E. de Barros, 6.5%; Coronel Silva, 3.5%; Ulysses Vianna, 1.0%.

Jose Antonio Moreira Filho’s luck seems to have run out in his final years. He was 64 years old when Vila Ipanema was launched and in bad health. Given his intimacy with the imperial court, the deposition of Pedro II in 1889 and his exile to Paris may have seriously undermined his business affairs. Surely, when the Count acquired the estate he had not countenanced an end to the imperial regime. The proclamation of the First Republic in 1889 was followed by political instability and economic crisis, and the flight of both human and financial capital. In the five years from the time of the coup-d’etat which ousted Pedro II to the launch of Vila Ipanema in 1894, the real, the Brazilian currency, lost 60% of its value relative to the U.S, dollar, and it would lose another 40% before stabilizing in 1899. The 1890s would also see the rise of Sao Paulo as Brazil’s dynamic economic center and the magnet for waves of Italian and Japanese immigrants.

By the mid-1890s almost all of the Ipanema de Moreira family was settled in Europe, either in Paris or Brussels. Brazil was far away and becoming a distant memory. When the Baron passed away in 1899, the majority control of Villa Ipanema went to Francisco Antonio Morreira who resided in Paris and had not lived in Brazil in 40 years.

 

The following account from Francisco Antonio’s son (nephew of the baron), Alberto Jorge de Ipanema Moreira, gives some color:

“In the spring of 1898 we travelled to Rio, my father, my aunt and I. My father and my aunt went to try to salvage what was left of a brilliant fortune. Their brother, the Baron of Ipanema, who was their proxy, was old and sick and his business affairs had collapsed. The only thing left were the immense land holdings in Copacabana and the “Praia do Arpoador’” now renamed “Vila Ipanema.” Following the death of the Baron of Ipanema, an agreement was reached with his heirs on one side and my father and my aunt on the other, that the remaining land for sale would be divided  so that the heirs would keep 35% and my father and my aunt would receive 65%. Though born in Rio, my father,  my aunt and my mother – she of English descent, Rudge by her father and Maxwell by her mother – had spent little time in Rio, having been sent at a young age to study in England. They had little notion of the assets they had in Brazil.”

Franciso Antonio Moreira, my great-great grandfather, was a bon vivant living the high life between Paris and Nice. He was married to Maria Tereza Rudge, the second daughter of Joseph Maxwell, and, presumably they both had inherited large fortunes from their parents. However, it seems that they lived well beyond their considerable means. More on this from his son Alberto Jorge:

“It would seem that this family settlement had been very favorable for my parents. It didn’t turn out that way; quite the contrary, they lived for the next thirty years receiving only crumbs. This great capital withered away, used only to cover the most basic and indispensable expenses. The lots in Ipanema sold poorly, and my father wanted to sell at any price. He was born a great lord, and had no notion of thrift. Very elegant and handsome, he loved sport, especially horses; generous and extremely charitable, of an uncommon righteousness, he saw no evil and was not made to manage a fortune.”

Francisco Antonio had six children: Alberto Jorge (Brazilian diplomat), Maria Luiza (my great grandmother who married Eugene Robyns de Schneidauer who was a Belgian diplomat), Leonora, Maria Thereza and Jose. All of them resided and passed away in Europe. The first photo shows him around 1900 in ceremonial Court regalia. The second photo is a family portrait taken in 1929, near the end of his life, where he is seated next to his wife in the middle, up front.

The following pictures shows Ipanema Beach at the turn of the 19^th century and in 1930. Notice how poorly developed it remained in 1930, still marked by the characteristics of the “restinga.”

The sales of the Vila Ipanema lots were painfully slow, as no one wanted to invest in that “fim do mundo.” This was in part because of competition from developers in Copacanana Beach which offered plenty of supply with closer proximity to the city and public transport. Moreover, though both Ipanema and Copacabana were marketed as “healthy and hygienic,” Ipanema was plagued by mosquito swarms when the lagoon periodically overflooded.

Poor sales also were caused by the delayed expansion of the tram service, which reached the General Osorio Square only in 1902. By the end of that year only 112 lots had been sold, which represented only about 6% of the available inventory.

Development expenses also ran out of control. Capital, administrative and selling expenses were still taking up over 60% of revenues in the early 1900s.  High construction costs led to the farming out of development work to a contractor in 1905, the Companhia Constructora de Ipanema, which did similar work in Copacabana and Leblon. In 1906, this company completed the embankments of the lagoon, providing a permanent solution to the flooding.

The table below shows the Vila Ipanema sales revenue stream from 1900 to 1930, by which time very few lots remained. These numbers are presented in 2020 U.S. dollars, adjusting for inflation and currency depreciation. The real lost half of its value over this period. The peak of sales occurred between 1911-1915, a period of economic strength and real appreciation. The evolution of the real from 1984 to 1930 is shown in the following chart.

Over this 30-year period, total Vila Ipanema gross revenues were $15.1 million (constant 2020 USD). Net revenues after all expenses amounted to $12 million, of which $6.5 million went to my great-great grandfather, Antonio Francisco Moreira. By the time of his death in November 1930, a small fraction of that capital remained.

Of course, in retrospect it is easy to say that this capital was grossly and irresponsibly dilapidated. Ipanema today is prime luxury real estate and a beachfront apartment on Ipanema Beach may cost 3 to 4 million dollars. Unquestionably, the best strategy for a long-term investor would have been to build a big wall around the property and wait.

However, the reality is that Ipanema remained a sleepy and distant neighborhood, particularly compared to Copacabana, until recent decades.  It was not until the 1960s that it received some notoriety as a fashionable destination. Since the 1960s, the social and cultural center of Rio de Janeiro has moved rapidly to the southern beaches, leading to huge appreciation in real estate.

When Antônio Carlos Jobim’s family moved to Ipanema in 1933 it was because his mother was recently divorced and could not afford to live in a nice neighborhood. For the same reason, a wave of immigrants settled there after W.W. II.  In the 1960s, Antonio Carlos (Tom) Jobim’s generation made Ipanema famous with the Bossa Nova.  It was from the terrace of the Bar Veloso on the Avenida Prudente de Moraes that Tom spied the “girl from Ipanema”, Helo Pinheiro, walking home bikini-clad from the beach, and the rest is history.

There are thousands of covers of Girl From Ipanema; the most recent from Anitta.

Astrud Gilberto Version

Getz Gilberto

Anitta

 

 

 

The Girl From Ipanema

https://apnews.com/article/anitta-girl-from-ipanema-rio-brazil-bb45163a74e7d47c23a38f09a4cbe1e3

 

 

Growth stocks, defined as those with underlying businesses growing much faster than GDP, flourished over the past decade. Tepid global growth, marked by aging work forces and declining productivity growth, put a high premium on those few sectors and companies with high secular growth, mostly in the tech driven digital economy. At the same time, extraordinarily loose monetary policies which drove real interest rates to negative levels around the world , sparked a speculative stock market frenzy, directed mainly to the most speculative “pie-in-the-sky” stories of  technological disruption.

For value investors the environment of the past decade was devasting, and believers in the old “Graham and Dodd” mindset of fundamental investing became an endangered species. In recent years, business publications and academic journals were full of declarations on “The Death of Value.”

Metrics from Google’s search engine give an idea of the narrative that dominated the scene, as shown below.

Of course, we know that this kind of media attention is a contrary indicator. For example, we can be confident that any business publication cover declaring the certainty of any investment trend is good evidence for the end of that trend (e.g. The Economist has marked multiple peaks and troughs in the Brazilian stock market with its covers.)

So, it really should not be a surprise with regards to value investing that, as Mark Twain once quipped: “The reports of my death are greatly exaggerated.”

Lo and behold, over the past year value has made an impressive comeback.

Warren Buffett, the doyen of “Graham-and-Dodd’s-Ville, who had underperformed the S&P500 for over ten years, made a big comeback over the past year, outperforming the index by 16%, as we can see below. A simple value strategy of weighing the index by fundamentals (sales and profits)  instead of market capitalizations also outperformed neatly.

The same has happened in emerging markets where, over the past year, EM value has had one of its best years ever relative to EM growth, leaving the vast majority of portfolio managers (today, almost all fully-declared growth investors or really “closet” growth investors) licking their wounds. We can see below that in every region  of EM (except for the GCC, for classification reasons) value has beaten growth by a huge margin.

As in the case of the U.S., a simple strategy based on fundamentals instead of market capitalization also beat the index by a huge margin and outperformed 90% of active managers in emerging markets.

What the future brings, we don’t know. But, historically, regime changes in favor of value can last for many years. If we have really moved into a more inflationary environment, which is typically good for value, then perhaps value has a ways to go.

 

1.

2021 saw more underperformance for international stocks (MSWORLD) and emerging markets stocks (EEM)s relative to the S&P500. The U.S. tech titans have become the darling of global investors, considered as the last remaining “safe haven”  asset in a low growth and risky world.

2.

EM ex China (EMXC) didn’t perform too badly in absolute terms, in line with MSCI World ex U.S. EM as a whole was weighed down by the collapse of China’s internet stocks (KWEB), the favorites of international funds.

3.

In 2021 investors learned that China cares about its currency and its bond market but not much about stocks , particularly those of “frivolous” companies engaging in anti-social activities (internet). While EM bonds (EMCB,EMHY) lost value relative to U.S. High Yield, China’s bonds (CBON) rose steadily.

4.

In the Chinese market (MCHI), stocks held mainly by foreigners (KWEB, CQQQ) did poorly but local stocks (CNYA) and, even more so, local tech stocks (CNXT) picked up the slack.

5.

Global EM stocks, despite the rally in commodity prices (GYX, industrial) commodities index), did poorly, which is unusual. Commodity-rich markets like Chile (ECH) and Brazil (EWZ) lagged badly. Commodity prices were driven by climate politics and inflation, no longer by China which is not the driver of global growth it once was.

6.

The collapse in the correlation between commodity prices and EM is seen in the extraordinary divergence between Chilean stocks and copper. Chile is overwhelmed by politics, and copper inflows are serving only to facilitate capital flight. Investors in Chile and elsewhere may be  anticipating the likely return of strict capital controls.

7.

EMEA ( Europe, Middle East, Africa) led EM equity returns in 2021, boosted by the oil-sensitive markets of the Persian Gulf.

8.

There’s always a bull market somewhere. In 2021 it was U.S. tech titans  and the Middle East. Taiwan, India and Vietnam were also winners.

 

9.

Latin America stocks (ILF) underperformed Asia EM (EMEA), as they have persistently for the past decade.

 

 

10.

Technology stocks outside of China fell back to earth in 2021. Latin American tech stocks, fueled by the happy dreams of global venture capitalists led by Softbank, experienced a general collapse.

11.

China’s share of the MSCI EM index fell sharply, replaced mainly by Taiwan and India.

12.

The fall of China’s internet titans caused significant changes to the MSCI EM’s top holdings. Indian stocks are becoming more prominent, a story likely to extend for the coming decade. Commodity related stocks (Gazprom, Vale, Al Rajhi Bank) are back, also a harbinger of things to come

 

13.

After a decade dominated by growth and momentum, other factors started to work in  2021. Value and small caps outperformed in global EM and every region. The very few still active value investors in EM finally had a good year while most EM active managers (by now almost all closet growth investors) suffered.

14.

All the traditional academic factors did well in 2021, led by small caps (EEMS) and momentum (PIE).

15.

The Covid-19 pandemic has been disastrous for much of emerging markets, the worse hit being Eastern Europe and Latin America. The fiscal impact (higher debt levels) and social consequences (impaired education for the poor) have severely undermined the growth prospects for Latin America.

China’s ongoing regulatory/political onslaught against popular growth stocks has left investors rattled and confused. Given the tense relations between China and the United States and determined efforts on both sides to reduce interdependence, questions are being raised on the basic viability of investing in Chinese assets.

In one camp, the stalwart aficionados for investing in China are keeping the faith. These include two groups with fundamentally different motivations: 1. Long-term investors like Bridgewater’s Ray Dalio and global asset allocators who believe that the continued rise of China’s economy and its capital markets are inevitable and that Chinese markets provide a invaluable source of portfolio diversification. For these investors, periods of turmoil are temporary and provide buying opportunities; 2. Major Wall Street firms, such as Blackrock and JPMorgan, which for years have lobbied both Beijing and Washington to get access to the Chinese capital markets. Not surprisingly, in recent days both Blackrock and JPMorgan have encouraged their clients to increase investments in China.

The idea of investing in Chinese assets for diversification is certainly compelling. The current process of decoupling  of the world’s two largest economies may also reduce the correlation of asset prices and improve diversification opportunities. Given high valuations and low forecasted returns in U.S. assets, diversification may be of particular benefit at this time.

The argument for diversification is most compelling for fixed income. China has a strong currency relative to the USD and its fixed income markets currently provide a large positive yield spread to U.S. instruments. The Chinese government cares about maintaining a stable currency and a solid  and growing fixed income market as this is seen as a pillar of the long term objective of raising the profile of China’s capital markets and reducing dependence on the USD. Significant amounts of foreign capital have flowed into Chinese fixed income over the past year. This should continue.

For other assets, the case is less clear. Real estate in China is as overbuilt as in the U.S. and generally has lower rental yields than in western countries. Stocks are a complicated story with a checkered past and unclear prospects.

Strangely, to a significant degree what most investors outside of China think of as Chinese stocks are an ingenious creation of Wall Street and Silicon Valley. U.S. venture capital firms who backed almost all the major China tech firms (Tencent, Alibaba, etc…) allied with Wall Street and a compliant Securities and Exchange Commission to bring these companies to  U.S. stock exchanges in the form of Cayman Island registered shell companies. Concurrently, the SEC agreed to significantly lower reporting standards for foreign issuers, supposedly to promote the development of U.S. capital markets. Ironically, none of these firms could have listed in China where listing and reporting standards have been and continue to be much more rigorous.

Unfortunately, the chickens have come home to roost. Weirdly, both Chinese and U.S. regulators now concur that the U.S. listings were a mistake. The disastrous recent listing in New York of Didi Chuxing, which was done hastily to ease the exit of VC firms, may have been the death knell for this model. This poses a serious problem for current VC investors in China’s tech “unicorns” who will probably have to list in China’s domestic markets from now on.

Moreover, the problems for the “unicorns” do not stop there. Recent political developments in Beijing indicate a strong negative bias against a large segment of the tech sector. One of the key attractions for the VC model of investing is the “winner-take-all” nature of many tech sectors built on scale and network effects. This dynamic, which leads to huge growth and value creation for investors, is anathema to Beijing. The emasculation of Alibaba’s Jack Ma was a warning that Beijing will not brook dissent from tech billionaires. The wealth concentration and political power that “winner-take-all” tech has given to U.S. moguls like Bezos and Zuckerberg is seen by Beijing as incompatible with its vision of a “harmonious” society led by the Communist Party.

It is also evident that Beijing sees the current U.S. driven tech model as an impediment to China’s economic development objectives as dictated by the China 2025 industrial planning goals. The primary focus of listed tech firms and unicorns has been directed at what authorities now see as either frivolous consumer distractions (e.g., e-commerce, gaming, social chat and video) or else fintech applications that disintermediate and destabilize the state-controlled  financial system.  Beijing believes that these firms are mobilizing scarce financial and human resources that would best be allocated to key strategic industries (semiconductors, electric vehicles, quantum computing, etc…). The following chart shows just how misaligned venture capital is with the government’s objectives. Interestingly half of the recent valuation of China’s unicorns was in fintech, presumably in companies that aim to disintermediate China’s state banks. However, as we saw in the case of Ant Financial, the authorities have no tolerance for anything that weakens state banks ability to serve as a pillar of China’s state capitalism and direct capital to preferred sectors.

China’s political agenda regarding corporations goes beyond tech. Beijing’s latest slogan – “common prosperity” – guides corporations to ‘continuously improve themselves in patriotism, innovation, integrity and social responsibility” ; in other words, to follow the dictates of the communist party.  The after-school education sector has already been crippled by regulators under the pretense that it accentuates inequality and unsocial behavior. This means tech companies will be expected to invest in areas of interest to Beijing, in a form of social service.

Looking forward, the problem for China’s stock market may be that heavy-handed government intervention in corporations to meet social and economic mandates will likely hamper profitability and investor support, resulting in lower valuations. As in the rest of the world, over the past decade in China the tech sector has been the driver of earnings growth and stock market appreciation. Without the dynamism of stocks like Tencent and Alibaba, which gave the Chinese market a high growth profile (exactly like the FAANG stocks in the U.S), the opportunity set in China will look more like those in other emerging markets; that is to say, dominated by cyclical, low growth value stocks.

 

The fact is that, despite the huge success of the tech sector, China’s stock market already has had underlying weaknesses. China’s corporate world is heavily dominated by a combination of very large state companies, which have the low-return profile of publicly managed firms around the world, and provincial government-sponsored firms that participate in “strategic” sectors, following the guidance of Beijing. The herd-like behavior of these local government firms leads to overinvestment and low returns. This occurs repeatedly, as we are seeing today with massive investments in electric vehicles and semi-conductors by local government firms. Finally, we have non-strategic sectors, such as consumer goods and services, where private entrepreneurs dominate and compete ferociously for market share.

This combination of a prevalence of state and local government firms and ferocious competition for private markets results in low returns and mediocre growth in earnings. We can see this in the following chart which shows the historical growth in earnings denominated in U.S. dollars for the Shanghai Exchange, the MSCI China Index (MCHI) and, for comparison purposes, the S&P500. When seen in relation to GDP growth, the contrast between China and the U.S. is shocking. The past three decades in the U.S. have been the heyday of financial engineering (leverage and buybacks) and globalization /offshoring and tax cuts have resulted in a major expansion of profit margins for U.S. firms. This has caused an extended period of earnings growth well above GDP growth, which is unprecedented. Meanwhile, in China corporations have sacrificed earnings to meet government objectives which has resulted in an equally extraordinary (by global standards) and extended period of earnings growth well below GDP growth.

 

Without the sizzle of tech stocks, Chinese equities may become a much more mundane affair, more in line with other emerging markets. This raises the question of whether the market should trade at lower multiples. We can see in the chart below that price earnings (PE) and cyclically adjusted price earnings (CAPE) ratios have been trending higher. If the government persists in suppressing dynamic private firms, we should expect multiples to move lower.

In conclusion, the prospects for Chinese stocks look poor, as it is probable that the market is experiencing a de-rating. Investors should focus their attention on the fixed income markets where they will be aligned with the policy objectives of the government.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Brazil’s dismal economic performance since the debt crisis of the 1980s has made it the poster child of the “middle-income trap.”  Over this period, Brazil’s economy, like those of most Latin American countries, stopped converging with developed economies, in sharp contrast to the high-growth emerging markets in East Asia and Eastern Europe. This extended period of economic failure has led to rising anxiety and calls for new approaches from policy makers and intellectuals  of both the left and the right.

Brazil’s Finance Minister Paulo Guedes has argued for a liberal agenda of privatizations, trade liberalization and smaller more efficient government, but he has run into the rock-hard resistance of powerful interest groups which extract benefits from the status quo and he has had only tepid support from his boss, President Bolsonaro. Unfortunately, though Guedes’s “Chicago School” framework would have produced high returns if introduced decades ago  today  it  seems woefully anachronistic in the context of a global reaction against neo-liberalism and the renewed popularity of industrial policy in the U.S. and its allies (WSJ). More in tune with the times, Brazilian financier Andre Lara Resende has caused an intellectual ruckus by advocating that Brazil break out of its torpor by adopting Modern Monetary Theory, the combined expansion of money printing and fiscal expansion that President Biden is pursuing in the U.S.  The underlying premise for both Lara Resende and U.S policy makers is that their respective economies have an abundance of high return public sector investment opportunities (infrastructure, basic research, broadband access, education, etc…) that pay for themselves through higher productivity and GDP growth and are easily financed today given the current extraordinary financial conditions of excess savings and historically low interest rates.

Lara Resende’s thinking reflects a profound change in the popularity of developmentalist economic theories in favor of a more activist state. The phenomenal rise of China with its super interventionist public sector and its sector-targeted industrial policies occurred during a 40-year period of neo-liberal tendencies and public sector retrenchment in the West. But now the pendulum has turned and a new generation of influential economists, such as Carlota Perez and Mariana Mazzucato, are convincing policy makers in the West that the public sector has a critical role to play in inducing innovation and growth. The Biden Administration is particularly smitten with these ideas, believing that these policies will put the U.S. on a higher, socially equitable and greener growth path.

In Brazil, these state-supported developmentalist policies have been deeply out of favor since the 1980s. Even the leftist ideologues of the PT administrations of Lula and Dilma rejected industrial policy in favor of social welfare initiatives. Since the 1980s, the Brazilian state’s capacity for investing in public goods has been severely eroded. Despite chronic fiscal deficits and a near-doubling of the ratio of public debt to GDP over the past decade, almost nothing has been spent on infrastructure. Also, government support for critical sectors through financial subsidies and research and development has dwindled. Over the past decades as government capacity for investing in public goods has fallen Brazil has become increasingly reliant on private capital for the scarce investments made in physical infrastructure, education and healthcare.

But this was not always the case. In fact, the kind of strategies advocated by Lara, Resende, Perez and Mazzucato have a better track in Brazil than neo-liberal ideologues like Guedes would admit. We can point to two of Brazil’s great success stories of the past decades as evidence of this: agroindustry and Embraer.

 

• Brazil’s world class agro-industrial sector was heavily supported by the public sector which sponsored through the agriculture research institute, Embrapa, innovation breakthroughs in tropical agriculture. Also, a wave of investments in roads and highways and port infrastructure during the 1970s provided the physical backbone for grain exports. Finally, for decades through Banco do Brasil, the government has provided cheap investment and working capital to the farm sector. All of this public sector support has induced the enormous success of thousands of entrepreneurs in the farm sector and related activities (services, meatpacking, etc…).
• Brazil’s aircraft manufacturer Embraer was heavily promoted and subsidized by the military regime (1964-1980) and provided with a captive market for military and civilian planes. The company’s success was always tied to the state-run Aeronautics Institute of Technology (ITA) which partnered with leading global research institutions such as MIT to achieve a high level of academic excellence. ITA has educated the vast majority of the engineers employed by Embraer, and one of its graduates, Ozires Silva, was the driving managerial force behind its success. Embraer and ITA are both based in Sao Jose dos Campos and support a cluster of world-class aeronautics expertise.

In today’s Brazil there are many opportunities to use the public sector to promote strategic industries that generate growth and employment. For example, tourism could benefit from long-term planning, infrastructure investments, vocational training and preferential tax and financial regimes. Green technologies, from ethanol to solar and wind, also would benefit from public support. The automotive industry stands to be thoroughly disrupted by electrification over the coming decade unless the public sector has a plan to maintain the country’s relevance in this industry. Unfortunately , under current circumstances there are serious impediments to pursuing these efforts; namely, the insolvency of the state and chronic fiscal incontinence.

The Impossible Trinity

Lara Resende assures that there is a long list of badly needed investments that would increase growth and productivity and therefore pay for themselves. However, given Brazil’s current high debt levels and chronic fiscal deficits, how do you convince financial markets to accept higher public debt levels? Any indication of increased public spending today, no matter how well intentioned,  would trigger capital flight, a weaker BRL and higher nominal interest rates. Under current circumstances, Brazil is severely constrained by The Impossible Trinity, the concept in economics which states that it is impossible to control the exchange rate, capital movements and monetary policy at the same time. In Brazil, any version of Modern Monetary Theory that pretends to finance stepped-up fiscal spending and debt accumulation  would almost certainly result in a combination of higher inflation and currency devaluation unless capital controls were imposed. Of course, any hint from policy makers that they are thinking of stricter controls on capital flows would accelerate outflows.

Whatever the MMT proponents say, in Brazil, and in many other countries around the world, there is no way to get around the fact that the current very high debt levels are an impediment to growth and tie the hands of policy makers. After a decade of quasi-recession conditions, Brazil will not follow a path of austerity to reduce these debt levels. So, in the end, it will have to follow the path of financial repression like developed countries were able to do in the 1950s and hope to do again this decade. Hopefully, Brazil will not try to inflate the debt away (which would place the adjustment burden on the poor) but rather will find a way to pass the cost to Brazil’s rentier class.

Mexico’s president Andres Manuel Lopez Obrador, popularly referred to as AMLO, is a quixotic figure, enthralled with the leftist ideals of the past and nostalgic for state-led economic growth.  But, at the same time, unlike most of the traditional left, he is both socially and fiscally conservative. This leads him to assume seemingly contradictory positions.  At heart a populist with a genuine preoccupation with the concerns of the poor, he dislikes debt and is a fiscal hawk ; and though he relishes fiery anti-American rhetoric, as president he has pursued pragmatic and cordial relations with the U.S. and even embraced the shameless Mexico basher Donald Trump “as a friend of Mexico who respects our sovereignty.”

AMLO’s contradictions were in full view in an important speech he delivered July 24 at the Castillo Chapultepec to commemorate the birthday of Simon Bolivar, the “libertador” of South America. Surrounded by diplomats and intellectuals from across Latin America, AMLO provided a whirlwind overview of Latin American history and centuries of oppression at the hands of Spain and the United States.  The nefarious rule of the hegemon continues to this day and only glorious Cuba has successfully defied it, AMLO declared.

AMLO repeated the standard claim of the Latin American political left that all of the region’s problems have been caused by the United States. According to AMLO, it all started when Thomas Jefferson convinced President James Monroe that “the Americas are for the Americans”  which led to the “disintegration of the peoples of our continent and destroying what was built by Bolivar.” Using military force and conducting overt and covert operations against independent countries, the U.S. has imposed its will in the region. Only the people of Cuba have resisted and they “deserve the prize of dignity, and that island should be considered as the new Numantia for its example of resistance, and I think that for the same reason should be declared a world heritage site.”

So far, so good; all this was standard leftist rhetoric pleasing to the ears of most Latin American politicians and intellectuals. This would have been a good time to finish the speech with warm applauses from the audience. But AMLO can be full of surprises. After the traditional bashing of the U.S. and the adulation for Cuba, AMLO suddenly pivoted from  confrontation to conciliation.

Actually, AMLO claimed, we now live in a new world where the past is not relevant.

Times have changed, AMLO said. The policies of the past benefit no one. “Unbeatable conditions” currently exist for a new relationship based on respect and common purpose. According to AMLO, the “rise of China has strengthened the opinion in the United States that we should be seen as allies and not as distant neighbors.”  Nearly 30 years of integration with the United States through NAFTA make the countries “mutually indispensable and well positioned to recover what was lost with respect to production and trade with China, than to continue weakening as a region and to have in the Pacific a scene plagued with warlike tensions; To put it in other words, we want the United States to be strong economically and not just militarily. Achieving this balance and not the hegemony of any country, is the most responsible and most convenient way to maintain peace for the good of future generations and humanity.”

According to AMLO, Mexico’s best way forward is to participate in a vibrant and successful North American economy. “Besides, I don’t see any other way out; We cannot close our economies or bet on the application of tariffs to exporting countries of the world, much less should we declare a trade war on anyone. I think the best thing is to be efficient, creative, strengthen our regional market and compete with any country or region in the world.”

Conclusion

What should we make of AMLO’s remarkable speech?  

First, It is obviously a sign that the initial contacts with the Biden Administration have been constructive. Given AMLO’s strange “love affair” with Trump and initial coolness towards Biden,  concerns of a falling out were real but it now appears that they were unfounded. AMLO’s positioning towards the United States  is grounded in a pragmatic understanding of interdependence.

Second,  in this speech AMLO expresses a sound understanding of Mexico’s strategic opportunities  in the context of the decoupling of the Chinese and American economies. This should  provide some comfort to investors on both sides of the border.

Constructive relations between the U.S. and Mexico and a understanding that the two countries  have a common purpose is certainly good news. Nevertheless, there remain many contentious issues to resolve.

From the American point of view, AMLO’s view on state domination of key sectors is not compatible with the updated USCMA trade agreement. Recent violation of contracts with American companies in the energy sector are not acceptable to the U.S.

Nevertheless, the conciliatory and optimistic tone of the speech is important. There are few countries in emerging markets today that have brighter prospects for their stock market than Mexico  which has low valuations, an undervalued currency and strong fiscal position. Mexico could  potentially attract huge investments for the reshoring of U.S. manufacturing supply chains which could boost GDP growth from the current low levels. Until today,  AMLO’s hardline anti-business stance has been the major impediment to investing in Mexico. A more pragmatic , conciliatory and forward thinking AMLO could possibly be a catalyst for better days ahead.

Different kinds of stocks perform differently during the business cycle. This is because markets tend to “fear the worst”  when recessions occur and “hope for the best” when economic expansions are going on. This means that economically sensitive segments of the market typically get crushed during contractions and then bounce back strongly when a recovery is anticipated.

The mega funds that dominate long only fundamental equity investing don’t care a lot about these business cycles.  Their “holy grail” is high “quality” which is defined by sustainably high returns that can be compounded over many years. These quality companies typically are not stressed by economic downturns so investors are happy to stay pat.

However, for traders and other investors that are more nimble the business cycle provides repeatable opportunities.

Economically sensitive stocks include value (low growth), small capitalization and cyclical stocks. These stocks are characterized by weaker balance sheets, high operational leverage and low market liquidity; they are also poorly covered by Wall Street and have less-acclaimed management.

In emerging markets, investors have plenty of opportunities to harvest returns from the business cycle. These markets have more and deeper economic downturns, and, also, greater variability in liquidity flows. Liquidity will dry up entirely during downturns and then ramp up giddily during the good times.

The past year gives a typical example of this investment cycle playing out in real time, just as expected. The chart below shows the performance of the Ishares EM small caps  ETF relative to the EM Index. Small caps underperformed sharply when the recession began in February of last year, and then bounced back strongly as recovery was anticipated. Normally, this outperformanse persists into the expansionary phase of the business cycle which for EM should persist well into 2022. Out-performance for the past twelve months is now 25%.

We see the same thing on a country-by-country basis. The charts below show performance of small caps relative to their country index for China, India and Brazil. The Chinese recovery is by far the most advanced of the three. In fact, Chinese authorities already are in a tightening mode, so we can say that this business cycle is well into the expansionary phase. Therefore, time may be running out on this trade. Chinese small caps outperformed the China index by 29% over the past year, so this trade has already been fruitful.

 

The India chart looks the same: a deep drawdown followed by steady performance. The Indian economy is still far from entering the expansionary phase so this trade may have a long way to go. Indian small caps have out-performed the India MSCI index by 36% over the past year.

 

 

Finally, the Brazilian chart also looks the same. Like India, Brazil has not yet entered the expansionary phase so this trade may have legs. Brazilian small cap stocks have now outperformed the MSCI Brazil index by 25% over the past twelve months.

 

When I first started investing in emerging market equities in the 1980s, I brought the traditional tool kit of an institutional investor. This was a  “Graham-and-Doddsville” view of the world, the same mindset applied by Warren Buffett: find “quality” companies – defined as ones with trustworthy management/controlling shareholders and profitable businesses in sectors with good growth characteristics – and ride them to compounding heaven.

At that time, I invested in Latin America, and, fortunately, good companies at low valuations were abundant. Latin America was coming out of the 1981-83 debt crisis and experiencing high levels of economic and policy volatility. The Brazilian market was dominated by individual investors who looked for yield and by traders who played short-term trends. “Quality” growth companies with good prospects were not really on the radar of these investors.

In the mid-1980s, both the World Bank’s IFC and MSCI introduced emerging markets stock indices for institutional investors, and, as a positive narrative grew on investing in developing countries (higher GDP growth leads to higher returns), portfolio capital started to flow into Latin America and other emerging markets. This was a time when macro hedge fund managers, such as George Soros, also started to deploy significant capital in these markets.

Lo and behold, emerging market stock prices surged. Five years after the launch of the MSCI Index in 1987, it had appreciated by over 6 times, as shown in the chart below of the Global Financial Data’s Composite EM Index.

As usually happens when new assets classes are created (e.g. Bitcoin), investors struggled to anchor valuations and they put long-horizon hopes well ahead of cool-headed skepticism. During the  1990-95 period  large U.S. and European pension and endowment funds began allocating to emerging markets stocks, and flows rushed into markets like Brazil.  Fundamental investment strategies worked very well, and the valuation parameters  for the “quality” gems which institutional investors looked for expanded  by 3 to 4 times. Investors like myself felt smart  and perfectly justified in charging 2-3% management fees for our services (today EM ETFs can be bought free of commission with management fees as low a 7 basis points, or 0.07%). I was convinced that my quality stocks would compound for ever in a “buy-and-hold” strategy, and this made me quite reluctant to take profits despite high valuations.

To make a long story short, the 1993 highs were not breached until 2004, eleven years later. It turned out that all was not a bed of roses in EM investing. The “Tequila” crisis in Mexico in 1994 was followed by the Asian crisis in 1997-1998 and the Russian crisis in 1999. The capital that poured into EM stocks during 1992-95 had terrible returns and what was left of it was largely sent back to safer shores.

Emerging market stocks bottomed in 2001. With the rise of China and the initiation of a commodity super-cycle,  a new EM bull market got under way, not unlike the previous one. During 2004-2007,   institutional investors came roaring back into emerging markets, making stocks like Mexico’s America Movil key holdings in global and even U.S. domestic portfolios (by the way, America Movil today trades at less than half the price of it 2007 high). The MSCI EM index peaked in 2012 and then did not breach that level until 2019, and this only because of the boom in Chinese tech stocks. Leaving out the Asian tech sector, most emerging markets indices are still well below the levels of ten years ago.

The boom-to-bust nature of emerging markets investing is a quandary for investors. Institutional  investors typically  are not well positioned to deal with this dynamic because the business dictates that inflows are concentrated at cycle tops and outflows peak when prices are collapsing. Also, many institutional investors endeavor to add value through fundamental research with a long-term focus, which makes analysts and managers oblivious to cyclical reversions (The latest fad in EM investing has been Chinese tech stocks).

So, what should an investor do to avoid the drawdowns in emerging market stocks?  Several investors have proposed rational approaches that are likely to succeed. GMO, a Boston-based value investor, recommends a two-pillared quantitative model that (1) pinpoints macro-economic risks and (2) monitors country-sector valuations, the premise being that success lies in owning cheap stocks in countries with low macro risk (GMO).  Verdad Capital’s Dan Rasmussen recently has offered an elegant systematic framework to harvest EM equity alpha by limiting market exposure only to high-return post crisis environments (Verdad Capital). My own approach is similar. I focus on (1) Global macro (USD flows); (2) Country macro (growth trends, current and fiscal accounts, debt dynamics);  and (3) Valuation (CAPE relative to country history.)  This model can be run effectively in a systematic manner.  Stock picking can be added as a fourth stage of the model, and my experience is that a combination of systematic algorithmic tools and discretionary research (focusing on management quality and growth prospects)  is most effective.

This approach requires a change in the buy-and-hold mindset to a disciplined focus on valuation parameters. It entails more turnover than a buy-and-hold approach, and therefore may be best suited for small-to- medium-sized funds (e.g. family offices).

Let’s look at Brazil to see how simple valuation tools can be used to exploit cycles.

The chart below shows the dollarized performance of the Bovespa index since 1967. That year is significant as it corresponds with the beginning of the “Brazilian Economic Miracle,” a period of nearly a decade of very high GDP growth. It was also a market bottom for the Bovespa, which had treaded water for the previous ten years. Not surprisingly, the stock market did very well from that point, appreciating by nearly twenty-fold over the next 4.5 years. Though Brazil would never again see this kind of “Asian- Tiger” GDP growth levels, the Bovespa has repeated these boom-to-bust cycles another five times, if we assume that another cycle began in 2016. Each one of these cycles has produced enormous returns over brief, but investable periods.

The Bovespa compounded at 11.3% annually over this period, which compares to 7.3% for the S&P500 (before dividends, which have been 85  basis points higher in Brazil.) However, the investor in Brazil experienced much greater volatility. Moreover, the Bovespa had negative performance in 24 years (compared to twelve for the S&P500) and suffered much greater drawdowns. Also, if we change the beginning of the calculation from the bottom of the 1967-1972 cycle to the top, then returns for the 1971-2020 period are only 5% a year. This highlights perfectly the importance of getting the cycles right.

Traditional buy-and-hold institutional investors are highly disadvantaged  at playing the cycle game, as it is usually at the peak of the cycles that they are able to raise more funds and they are obliged to deploy them. On the other hand, in Brazil a generation of macro hedge fund traders hit pay dirt in the 1983-1997 decade, systematically playing the cycles in an anti-buy-and-hold framework. In fact, these investors exploited the gullible foreign institutional investors, feeding them stories and front-running their flows. Knowing when to cash out of the market has been the key to success for Brazilian traders.

Fortunately, market cycles are often clearly marked by valuation signals. Invariably, the great cycles of the Bovespa have started when valuations were very low and the currency highly  depreciated. The dollarized cyclically adjusted price earnings ratio (CAPE) is a simple methodology that has clearly identified the key trading points, as it smoothens out the highly cyclical path of earnings in Brazil as well as the persistent multi-year trends of BRL relative to the dollar.

The chart below shows both PE and CAPE multiples for Brazil over the 1986-2020 period. Referring back to the previous chart, it is clear that the CAPE has proven to be well suited for identifying market extremes in 1990 (buy), 1997 (sell), 2002 (buy), 2008 (sell), 2010 (sell) and 2016 (buy). The CAPE therefore can be useful to evaluate valuation risk in specific countries (measuring levels relative to history).

Combining a macro framework with a CAPE valuation methodology works well to capture market surges  and avoid steep drawdowns in Brazil and across emerging markets. This approach is systematic and easy to implement and can be effectively incorporated into a global allocation  strategy .  

 

 

 

 

 

 

 

Por que este especialista em mercados emergentes está comprando commodities Geraldo Samor e Pedro Arbex Em mais de 30 anos de mercado, Jean …

Leia mais em https://braziljournal.com/por-que-este-especialista-em-mercados-emergentes-esta-comprando-commodities

https://www.linkedin.com/video/live/urn:li:ugcPost:6726507673770082304/

Since 2004, The World Economic Forum (WEF), a Switzerland-based NGO with strong ties to the business community, has published the Global Competitiveness Report  (GCR) which ranks countries on the basis of their ability to compete in the world economy.  The report (Link) gives us a snapshot of where countries stand relative to their peers on a wide variety of measures, and long-term comparisons provide a good indication of which countries are taking the steps to improve their ability to compete and prosper.

The methodology of the GCR incorporates a wide variety of factors, but the focus is squarely on the quality of institutions and other “soft” elements, rather than on the quantity of capital and labor. The rankings purport to show which countries provide the best business environment to unleash the animal spirits of  entrepreneurship and innovation.This may be a particularly useful approach in this day and age when increasingly growth seems to be driven by innovation and the other intangible forces that impact “total factor productivity.”  Importantly, the report shies away from passing judgement on the pros-and-cons of  democratic versus more authoritarian regimes, beyond what the immediate implications might be for business and development.

The CGR ranks each one of 144 countries according to 12 “pillars” of competitiveness:

1. Institutions
2. Appropriate infrastructure
3. Information and communication technology adoption
4. Macroeconomic stability
5. Health
6. Education and skills
7. Efficient goods markets
8. Efficient labor markets
9. Efficient financial markets
10. Market size
11. Business dynamism
12. Innovation capability

 

Each one of these pillars is explored in detail.  The following chart shows the latest WEF, Global Competitiveness Rankings, with emerging markets highlighted in bold black and frontier markets in red.

The first quartile are mainly “Western” democracies, with Japan, Taiwan and Korea representing Asia. Two, non-democratic, authoritarian and dirigiste regimes –Singapore and UAE –also make this list.

The second quartile includes the remainder of the Western democracies (except for Greece), most of eastern Europe and the remaining Middle-East authoritarian states. This quartile of semi-competitive countries also includes China, Indonesia, Malaysia and Thailand in Asia and Chile and Mexico in Latin America. These countries range across the political spectrum, from highly authoritarian to fully democratic. China is very close to reaching elite status, and sees itself on the same path as Singapore.

The third quartile are countries with serious competitive issues this includes many core emerging markets such as Colombia, South Africa, Turkey, India and Brazil. This group’s political inclinations also range from dictatorships (Vietnam) to full democracies (Brazil).

The last quartile shown here (not including another 44 countries at the bottom of the rankings) are all severely impaired from a competitive aspect. This includes Argentina, Egypt and Pakistan in emerging markets and Bangladesh and Nigeria in frontier markets.

The next chart below shows the evolution of rankings over the past 10 years.  The left side of the chart shows countries with improved or no change in ranking, while the right side shows countries with declining rankings. EM economies with either significant improvements or declines are highlighted in bold.

 

Non-competitive countries with declining rankings are those highlighted in the bottom of the right-hand side of the chart. These countries should be considered problematic for investors, and it is therefore no coincidence that these countries suffer from low investment and capital flight. This includes major economies and population centers that are of major concern to emerging markets investors – Brazil, India, South Africa, Nigeria, Egypt and Pakistan.

Trade Wars

• The great decoupling (Oxford Energy)
• KKR sees opportunity in China decoupling (KKR)
• Banning technology will backfire on the U.S. (FT)

India Watch

• Modi’s self-inflicted economic mess (project syndicate)
• India’s digital transformation (McKinsey)

China Watch:

• Expected returns in China (UBS)
• China-Russia: cooperation in Central Asia  (AsanForum)

China Technology

• China phone sales now require face scan (venturebeat)
• China’s Digital Economy (IMF)
• China’s Digital Trends (McKinsey)
• Interview with Alibaba’s CEO (McKinsey)
• Inside China’s biopharma market (McKinsey)
• China Internet Weekly (Seeking Alpha)

Brazil Watch

• Brazil-U.S. ties with Trump-Bolsonaro (The Dialogue)
• The bear case for Brazil (seeking alpha)

EM Investor Watch

• The open secret of development (project syndicate)
• IMF, Global Financial Stability Report (IMF)
• Russia, the cheapest market in the world (seeking alpha)
• Global Competitiveness report 2019 (WEF)
• Naspers strategy to create value (FT)

Tech Watch

• Risks and opportunities in the battery supply chain (squarespace)
• Investing in Asian Innovation (Oppenheimer)
• Trends in battery prices (BNEF)

Investing

• Larry Hite on trend following (marketwatch)
• Ten years of performance is still just noise (Swedroe)
• Joe Greenblatt on value investing (wsj)
• The correlation between stocks and bonds (Axioma)
• A taxonomy of moats (reaction wheel)
• An investment thesis for the next decade (Gavekal)

 

 

 

 

 

 

 

 

 

The Economist’s Big Mac Index ( Link  ) looks at the dollar cost of a hamburger sold by McDonald’s restaurants in some 60 countries. The index shows a remarkable range of prices around the world. In the latest survey, the most expensive burger was found in Switzerland ($6.54) and the cheapest in Russia ($2.04).  Presumably, these hamburgers are identical, with the same combination of bread, beef patty, lettuce and sauce. The price in each country should reflect the cost of the materials, labor and rent, profit margins and taxes. The index pretends to shed some light on the relative costs of doing business in different countries, and, given that it has been measured for some 30 years, it can also provide an indication of the evolution of business costs. Moreover, it can be used as a proxy to measure the relative competitiveness of currencies around the world.

The Big Mac data confirms the strength of the USD following a 8-year period of USD appreciation against both developed and emerging market currencies. EM currencies are inexpensive compared to the high levels of 2007-2011 and generally in line with long-term historical levels. Competitive currencies, low earnings multiples and higher GDP growth compared to the United States are the foundation for a positive outlook for EM stocks.

 

 

In terms of specific emerging market countries, the relative strength of the Brazilian real is noteworthy. The BRL is the most expensive EM Big Mac currency, which is curious given the depressed economy, current account deficit,  low savings and low interest rates.

The data is detailed below for the primary EM countries of interest to investors.

It is important to view the data in a country-specific historical context to understand what the data means. We look below at several specific cases, and compare the data for the Big Mac Index with the Real Broad Effective Exchange Rate (RBEE) as measured by the Bank for International Settlements (BIS)

Brazil

The first thing to note is that the current relatively high valuation of the Brazilian real is not an anomaly. Except for a brief period in 2015, one has to go back to 2000-2004 to find a “cheap” real. The current “weakness” of the BRL appears largely explained by the strength of the dollar, which has appreciated against almost all currencies over the past eight years. The data is confirmed by the BIS RBEE data which shows the BRL to be about in line with its 25-year average. The BRL probably has some moderate potential for appreciation when the economy experiences a more robust economic recovery and will quickly find itself in overvalued territory, and impediment to trade and investment. The strong BRL is very difficult to reconcile with the Bolsonaro’s market-opening initiatives, such as the recent trade agreement with Europe.

Thailand, Chile, South Korea, and Colombia

The Thai Baht has been on a path of appreciation, driven mainly by capital inflows. This is reflected both in the Big Mac and RBEE data, and should be a major headwind for a country that relies on exports in an increasingly competitive market and in a region where most countries have kept their currencies very competitive. Chile, South Korea and Colombia all have currencies that are strong relative to other EM currencies but more-or-less neutrally positioned relative to their own histories.

Peru

The data on the Peruvian sol is confusing. The Big Mac Index shows a currency that has weakened well below its peak and appears to be at a competitive level. However, RBEE numbers point to significant overvaluation, near peak levels.

China

The Chinese yuan is on a long-term gradual appreciation path, in line with the growth and increased sophistication of economic output. This is confirmed by both the Big Mac and RBEE data. The recent dip in the yuan is a response to trade war tensions. Despite a burgeoning current account deficit and capital flight, Beijing appears committed to a stable yuan to further its gradual internationalization of the currency.

 

Turkey and Argentina

By any measure, the Turkish Lira is very undervalued.  The Big Mac Index shows Turkey at record-lows both relative to its history and compared to other countries. This confirms by the RBEE which shows Turkey starting to rebound from near record-low levels. For an investor in Turkish assets, the very cheap lira should provide a strong boost to total dollar returns when the economy recovers over 2020-2022.

The same goes for Argentina. The peso is cheap by any measure and should provide support for asset prices if politics do not get in the way. Argentina is much better positioned to benefit from free-trade deals than Brazil.

Russia

Russia provides an interesting contrast to Turkey. Though the Russia Big Mac is very cheap, it is only marginally cheaper than it has been for the past 20 years both relative to the USD and to other countries. The BIS RBEE shows that the ruble is only cheap relative to the peak of the 2008-2012 commodity boom but in line relative to history. This points to moderate upside for the ruble, unless, of course, oil prices rally strongly.

South Africa

In the same vein as Argentina, the rand is inexpensive by any measure and should provide support for asset prices, if politics and capital flight do not get in the way.

Malaysia and Taiwan

Both Malaysia and Taiwan are committed to maintaining their currencies at very competitive level, to support exports in an increasingly hostile world for small export-oriented countries.

Indonesia and the Philippines

Unlike Taiwan and Malaysia, Indonesia and the Philippines have allowed their currencies to appreciate, driven by capital inflows, though from a Big Mac basis they are in line with history.

India

The rupee is on an a gradual appreciation trend. The rupee is likely to trade increasingly in line with oil prices as the country has become the biggest importer of oil in the world. Currency strength is not likely to be a boost to investor performance from current levels, unless oil prices collapse.

Mexico

The Mexican peso is very cheap, but on a downward trend. AMLO’s policies are driving both foreign and domestic capital out of Mexico while Trump unsettles investors with trade tensions.

Trade Wars

• Balkanizing technology will backfire on the U.S. (FT)
• A G-2 world (project syndicate)
• Ian Bremmer (Aviva)
• Post-dollar networks (project syndicate)
• Investing in the age of deglobalization  (FT)
• Is American diplomacy with China dead? (AFSA)

India Watch

• India’s digital transformation (McKinsey)

China Watch:

• China and the World (Mckinsey)
• The China-Russia partnership (The Economist,Link))
• Chinese internet weekly (seeking alpha)
• China internet report (SCMP)
• China’s elite obsession with Harvard (The Economist)
• China’s Silicon valley (The Economist)
• China’s sport-shoe capital  (SCMP

China Technology

• Inside China’s biopharma market (McKinsey)
• China Internet Weekly (Seeking Alpha)
• China’s food delivery war (Bloomberg)
• How China took the lead in 5G technology (WP)
• China’s MIC 2025 plans are roaring ahead (SCMP)
• China’s EV future (The Econoist)
• China’s EV bubble (Bloomberg)

Brazil Watch

• Brazil-U.S. ties with Trump-Bolsonaro (The Dialogue)
• The bear case for Brazil (seeking alpha)
• Business optimism returns to Brazil (FT)
• The great Brazilian foreign policy realignment (National Interest)

 

EM Investor Watch

• Naspers strategy to create value (FT)
• Latin America and Europe come closer (The Economist)
• Another bad week in South Africa (The Economist)
• The days of Erdogan may be over (Spiegel)
•  Don’t give up on Turkey (WSJ)
• Vietnam’s Vin Group (FT)
• Vietnam shapes as key winner from U.S.-China trade war (Lowy)

Tech Watch

• Investing in Asian Innovation (Oppenheimer)
• Trends in battery prices (BNEF)
• Mary Meeker’s Internet Trends report (techcrunch)
• Germany is losing the battery war (Spiegel)
• Does automation in Michigan kill jobs in Mexico? (World Bank)

Investing

• Fooled by randomness (macro-ops)
• The imperative for international diversification (Swedroe)
• The end of sell-side research (Epsilon)
• Understanding why currencies move (macro-ops)
• EM value as an anti-bubble (research affiliates)
• Interview with Robert Wilson, Part I (street.com) part II (street.com)
• Factor returns in emerging markets (SSRN)
• Asia’s future is now (McKinsey)
• Factor premia and factor timing (AQR Capital)
• Bubble, bubble, toil and trouble (Research affiliates)

 

 

 

 

 

 

 

Every year the oil company BP presents a twenty-year outlook (Link) for global energy markets. The latest report released last week points to  the  persistently rising importance of emerging markets in  the global market for imported oil. China has had the most impact on oil markets over the past two decades, increasing its imports from a little over one million barrels per day (b/d) at the turn of the century to over nine million today. China largely replaced the  market presence of the United States, which has seen its oil imports fall from 12 million b/d in 2007 to nearly zero today. But China’s growth in demand for oil is now slowing ,and India is now rising as the primary source of marginal demand for imported oil. Unlike China, which has had a large and growing domestic production of oil, India’s high demand growth is expected to be met almost exclusively by imports. The rise of India as a major actor in the oil markets comes at a time when the U.S. has become self-sufficient in oil and Europe’s demand for imported oil is declining. The result of this is that India is set to become the major buyer of Persian Gulf oil. The following chart from the BP report illustrates India’s growing role in the market. While combined demand from China and OECD countries is slated to remain flat, India and emerging Asia and other emerging markets will experience high demand growth. India’s oil demand is expected to rise by 3.1% per year through 2040, from 5 million barrels/day to 9 million b/d. BP expects India’s oil production to decline slightly from the current 1 million b/d of production, so that demand growth will have to be supplied by imports, which will rise from 4 million b/d to about 8.2 million b/d. BP expects total global demand for oil to fall from 96 million b/d to 82 million b/d between 2017 and 2040, which means that India’s share of global oil demand will double from 5% to 10%. China’s oil demand is expected to rise from 13 million b/d to 15 million b/d, while production stays around 4 million b/d. This means Chinese imports would rise by 2 million b/d, from 9 million b/d to 11 million b/d, half as much in volumes compared to India. As India and China come to dominate the market for imported oil, both the U.S. and Europe will become less significant. The U.S. is expected to export 5 million b/d in 2040. Over this period, according to BP’s estimates, Europe’s import would fall from 11 million b/d to 7 million b/d. Where will India and China source their oil? In the chart below, the BP data points to the same primary sources that have met demand for oil imports in the past decades: Russia and the Middle East. China is already cementing its energy ties with Russia, building a series of pipelines to Siberia and importing Russian Artic liquid natural gas (LNG). India, on the other hand, has as its traditional supplier the Persian Gulf, which makes sense from a logistical point of view. Certainly, as they always have in the past, the geopolitics of oil will require that both India and China become much more involved in international politics. With the U.S. no longer importing oil from the Middle East and, perhaps, entering a period of lesser foreign-policy engagement, China and India will increasingly have to  actively defend their strategic commercial interests. We have already seen this clearly wth regards to Indian imports of Iranian oil. India  has increased its imports of Iranian oil sharply in recent years, and China and India are today Iran’s two biggest clients. Interestingly, both received waivers from the U.S. Iran sanctions and continue to buy Iranian oil. India’s dependence on oil imports with their highly volatile prices also will create greater macro-economic challenges. Growing oil imports may pressure the trade and current accounts. Unlike China, which experienced huge trade surpluses during its decades of dependence on the importation of oil and other commodities, India runs chronic current account deficits. These are likely to become more difficult to manage, leading to increased currency volatility. Trade Wars  

• Why a U.S. China trade deal is not enough (Project Syndicate, Minxin Pei)
• Trade truce will not end China-U.S. tension (SCMP)
• A look at the future of Sino-U.S. relations (Li Lu Himalaya Capital)
• The internet has become a battleground between the U.S. and China (WSJ)
• Senator Rubio’s report on the China threat (U.S. Senate)
• Is China or Russia are new rival (The Atlantic)

India Watch

• India turns its back on Silicon Valey (Venture beat)
• India is right to resist cancerous U.S. tech monopolies (venture beat)
• 5 more years of Modi? (Lowy)
• China is leading FDI in India (SCMP)
• India curbs create chaos for Amazon and Walmart (Bloomberg)
• India’s big upcoming election (Lowy)
• India’s vote-buying budget (Project Syndicate)

China Watch:

• China’s property market slowdown (WSJ)
• Cracking China’s asset management business (Institutional Investor)
• Haier’s turnaround of GE Appliances (Bloomberg)
• China’s consumer is losing confidence (WSJ)
• China real estate bubble (Nikkei)
• Will China fail without political reform? (Project Syndicate)

China Technology  

• China will corner the 5G market (Wired)
• CTrip’s strategy (Mckinsey)
• DJI’s rise (SCMP)
• China’s decade-long Bullet-train revolution (WIC)
• China’s lead in EVs and EV infrastructure (Columbia)
• China’s high-flying car market (McKinsey )
• China’s place in the autonomous vehicle revolution (McKinsey)
• Can China become a scientific superpower? (The Economist)

Brazil Watch

• Brazil’s crucial pension reform (Washington Post)
• Brazil’s finance guru (FT)
• The rise of evangelicals in Latin America (AQ)

EM Investor Watch

• Make hay while the sun shines in emerging markets (FT)
•  
• Globalization in Transition (mckinsey)
• World Bank Report, Global Economic Prospects (World Bank)
• Indonesia’s economic populism (The Economist)
• EM’s Corporate debt bomb (FT)

Tech Watch

• Robots and farming (Realclear markets)
• American energy independence is here (AL Advisors)
• Solving the productivity puzzle (Mckinsey)
• Autonomous trucks are coming fast (Mckinsey)

Investing

• Who is on the other side? (Mauboussin)
• 50 reasons not to invest for the long-term (Abnormal returns
• Not one Ivy League endowment outperformed  past 10 years (Institutional Investor)
• Stock market charts you never see (Papers)