The Brazilian government has just released its budget balance for August, and the purpose of this report is to assess the impact of the budget on macro-fiscal flows and investment markets.
Brazil is a component in our macro-fiscal flow portfolio and we need to watch developments there like a hawk as not to do so would be imprudent.
A positive macro picture for a land one is looking at investing in is a real prerequisite, and the purpose of this report is to assess if Brazil has a positive macro environment within which to invest.
One can summarize the national accounts in the following formulae:
Private Sector [P] = Government Sector [G] + External Sector [X]
GDP = Private Sector [P] + Government Sector [G] + External Sector [X]
These are accounting entities and are true by definition.
See the methodology section below for more detail on this formula.
The private sector is where the stock market is and we as investors want the stock market to go up. The stock market can only go up if the flows into it are positive. The private sector derives income from three sources:
Credit creation from banks – Banks lend more than is repaid in loans.
Externally from overseas commerce – Exports bring in more than imports cost.
Government spending – More is spent than taxed.
In an ideal scenario, the private sector would receive large and growing income flows from all three sources, and at the very least, the overall impact should be a positive flow even if one or two of the three flows are negative.
The stock market in the private sector, as well as all other private financial assets, should rise if the overall income flow into the private sector is positive. Certainly, the stock market would be unlikely to rise if the income flows were negative. Even in a shrinking economy, some sectors can grow while the rest of the pie shrinks such as defensive sectors like consumer staples and utilities.
We will look at each inflow in turn and start with the private sector, all the while updating our forecast result based on the latest data.
The chart below shows the level of private credit creation entering the private sector through commercial banks.
The charts show that the fall in credit creation is decelerating and starting to bottom. This month was a positive result showing more loans created than repaid.
The rate of deceleration is half what it was in 2016 and may well end up positive for the year and will certainly be a better result than 2016 if the present trend continues.
The external sector captures trade and commerce with other countries and is best captured by the current account. The current account is exports minus imports, and it also captures capital flows in and out of the country from financial transactions and investments. A positive overall result is best.
The chart below shows the current account balance. Brazil has a poor current account balance, with more funds flowing out than in. Like the credit creation picture, it is improving though. This year has seen a series of surplus months and 2017 is looking to be less of a drain than 2016 on overall fiscal flows.
The government budget is shown in the chart below.
This is the new data that we have and can use to update our model and forecast. The new data is positive as the government is still adding funds to the economy and so far looks to add more this year than last.
The government budget picture is a healthy one with big injections of funds into the private sector and is indeed the sector doing the heavy lifting and causing asset prices to rise.
The government plans to continue spending and is indeed having trouble not spending as this article from Bloomberg documents.
This is a positive trend going forward and looks to have years left to run.
A government in political chaos but locked in spend mode could not be better for the private sector and is the opposite of what most other advanced countries in the world have at present.
One popular myth is that government deficit spending is inflationary. Brazil’s deficit spending is one of the highest in the world, and yet inflation is falling as this article from Investing.com shows.
Sectoral Analysis Methodology
Each nation state is composed of three essential components:
The private sector
The government sector
The external sector
The private sector comprises the people, business and community, and most importantly, the stock market. For the stock market to move upwards, this sector needs to be growing. This sector by itself is an engine for growth and innovation; however, it needs income from one or both of the other two sectors to grow.
The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained. For a sovereign government with a freely floating exchange rate, any financial constraint such as a matching bond issue is a self-imposed restriction. A debt ceiling is also a self-imposed restriction as is a fiscal brake.
The external sector is trade and commerce with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.
For the stock market in the private sector to prosper and keep moving upwards, income is required to be put into the flow. Otherwise, the sector can only circulate existing funds, or is being drained of funds and is in decline.
The ideal situation is that the private sector has a net inflow of funds and is always growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
The following formula can express this relationship:
Private Sector = Government Sector + External Sector
GDP = Private Sector + Government Sector + External Sector
These are accounting entities.
For the best investing outcome, one looks for countries with stock markets located in private sectors that are receiving positive income flows overall. Top marks come where private credit creation, the government sector, and external sector are all in plus and trending upwards.
Conclusion, Summary, and Recommendation
When we take our inputs and place them in our formula, we can calculate the following sectoral flow result based as a percentage of GDP. The numbers in absolute terms are growing because GDP is increasing.
Private Sector Credit Creation[P]
(Source: Trading Economics and Author calculations based on same)
Brazilian sectoral flows are positive and strong at 8.3%. Looking forward, it appears that growth rates for the external sector and private credit creation are improving. The large government sector flows look to be maintainable for years given the political gridlock has taken place at a time of high flow rates.
There is scope for financial assets such as stocks, bonds, and real estate to rise given that the private sector is receiving a positive inflow of funds.
An investor wishing to have exposure to the Brazilian stock exchange can do so through the following ETFs:
- iShares MSCI Brazil Capped ETF (EWZ)
- First Trust Brazil AlphaDEX Fund (FBZ)
- VanEck Vectors Brazil Small-Cap ETF (BRF)
- Direxion Daily Brazil Bull 3x Shares ETF (BRZU)
- iShares MSCI Brazil Small-Cap ETF (EWZS)
- ProShares Ultra MSCI Brazil Capped ETF (UBR)
- Global X Brazil Consumer ETF (BRAQ)
- Global X Brazil Mid Cap ETF (BRAZ)
- Deutsche X-trackers MSCI Brazil Hedged Equity ETF (DBBR)
I first recommended a position in Brazil in this article in December 2016, and since that time, the above ETF has risen in value by 50% and paid a modest 1.67% dividend income as the chart below shows.
In June this year, we had the Temer Tapes scandal, upon which I bought the dip and have been well rewarded since. The macro-fiscal flows are still strong, and Brazil is still a buy.
Disclosure: I am/we are long EWZ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.