World Cup fever has hit Latin America and even though Peru, where I’m writing, is not competing, I’ve been busy investigating the tournament for The New World readers.
As part of my ‘research’ on Saturday, I went to a Colombian bar to watch them beat Greece, then on to a Uruguayan steak house to watch their shock defeat to Costa Rica. I was at it again on Sunday with another day of gruelling fact-finding.
In the morning I met up with some Ecuadorians, only to see them undone by a cruel, last-minute goal from the Swiss, took a nap during the Honduras game – sorry to fans of Los Catrachos – but returned with vigour to make it to another steak house – this time Argentinian – to watch them squeak past Bosnia.
It was a tough weekend, but someone had to do it…
However, the best World Cup experience that I’ve had out here so far came on Thursday – when I managed to wangle an invite to the Brazilian embassy’s opening game party.
Brazil has fascinated investors in recent times. Just a few years ago, the country’s economy held such promise – everyone tipped it for success – but that has sadly failed to materialise.
Today – with some help from a sporting legend – I want to look at what went wrong with Brazil’s economy and see if there’s any chance of a turnaround.
How the fairy tale went wrong
I’ve got to hand it to the Brazilians – the embassy party was phenomenal. But behind the extravagant hospitality was a clear message.
Brazil has invested a lot in this World Cup and is determined to reap some benefit from it. The embassy was doing its bit to try to generate some positive PR and counteract some of the negative headlines we’ve been reading about the event’s cost and organisation.
It’s remarkable how much things have changed. When Brazil won the bid to host the World Cup in 2007, it was seen as another sign of the country’s irrevocable rise to world power status.
The economy was growing at more than 6% per year, it had made a monster oil find and the stock market was on its way to record highs.
But since then that story has come apart.
Brazil’s economy has flatlined over the last few years and the stock market has plunged. To add insult to injury, even the country’s organisation of the World Cup has come in for criticism.
So where did it all go wrong?
Lessons from George Best
The current criticism of Brazil reminds me of a story about George Best – the finest player never to go to a World Cup.
Years ago, the great footballer, by then enjoying his early retirement, had spent the day at the races with a Miss World and won a fortune. Unsurprisingly he felt like celebrating, so when he and his companion got back to the hotel, they called for some champagne.
But when the waiter arrived and saw the Miss World lying on a bed covered in thousands of pounds, he asked, “Mr Best, where did it all go wrong?”
Winning big at the horses and spending a bit of quality time with a Miss World would count as a good day by my standards, but I guess the waiter would have liked to see Best achieve more of his potential on the pitch.
My point is that everyone measures success and failure in different ways.
In the last 15 years, Brazil has achieved an awful lot. It’s gone from being a macroeconomic basket case to a relatively well-run modern economy.
Moreover, an estimated 35 million people have been lifted out of poverty since 2000, which is surely what all this economic growth is about.
That’s not a bad effort, but the trouble is, investors, just like George Best’s waiter, expected more.
Brazil’s economic own goals
So far for The New World, I’ve been pretty bearish on Brazil – preferring to focus on the countries of the Pacific Alliance. But I can see why other investors might have bought into the Brazil story.
A giant domestic market of almost 200 million people, a ridiculous abundance of natural resources and positive demographics all seemed factors that would drive growth.
Meanwhile, successive administrations had managed to tame Brazil’s traditional bugbear of high inflation to create a stable macroeconomic backdrop for investors.
But just as investors climbed on board, the train started to go off the tracks.
Some of this was down to external factors. Falling commodity prices hit some of the country’s exports, while Brazil was also hit when investors started to lose faith with emerging markets in general and money flowed back to developed markets.
But there were also lots of Brazil-specific factors. As Nomura’s Latin America analyst Tony Volpon explained to me recently, Brazil’s protectionist stance means that many of its firms are less competitive than their international peers.
And by not delivering measures that can improve productivity – like infrastructure – government policy has throttled growth. Growth was 7.5% in 2010, but has been under 3% in every year since then.
The government’s response of lowering interest rates and boosting public spending made things worse, says Volpon. “It just served to exacerbate supply constraints and fuel an import boom, which led to widening current account deficits.”
The market has reacted to all this with increasing disillusionment and the country’s main index, the Bovespa, is down by about 22% since 2011.
Will things change?
At the time, George Best said he was bemused by the waiter’s comment. As he could see it, things hadn’t gone too wrong for him. Yet years later, Best would admit that “perhaps he saw something in me that I didn’t…”
So are today’s investors showing waiter-like prescience about Brazil’s future problems? Or are they missing the country’s potential?
The key to that question could lie with the Brazilian electorate. In October, they go to the polls and have the choice between the current administration of President Dilma Rousseff, and its poor economic track record, or the leading opposition candidate, market-friendly Aecio Neves.
After seeing the latest polls, Volpon now thinks that Rousseff looks likely to lose the elections in October. And although his view remains in the minority, it’s clear that Rousseff’s approval rating is sliding.
A new market-friendly government could help to unlock Brazil’s growth potential. Or even the pressure of a challenger could force the government to adopt more pro-growth policies.
And as my MoneyWeek colleagues Chris Carter and Andrew Van Sickle have noted recently, the Brazilian stock market is cheap right now. Trading on a cyclically-adjusted price-to-earnings ratio of 10.2, it’s one of the world’s cheapest major stock markets.
But I’m not changing my bearish stance on Brazil just yet.
I’ve never been a fan of basing my investments on the outcome of future elections. Indeed, Sunday’s tight Colombian election, where incumbent Juan Manuel Santos survived a scare to win a second-round vote, shows how these things can go down to the wire.
But if there’s a change of tack in Brasilia, I will start to look for new investment opportunities in the region’s biggest economy.