Dear Investors,
The second quarter of 2024 was marked by a major detachment between the domestic and international economic scenarios. Globally, the disinflationary path regained momentum, marked by signs of cooling in US growth, notably in employment and inflation metrics. Long-term US interest rates reflected this dynamic, falling sharply over the quarter. In the local environment, concerns about fiscal sustainability triggered the underperformance in emerging market peers.
The US stock market remains close to all-time high, with a select group of technology giants accounting for most of the gains in this semester amid the focus on artificial intelligence. Companies more exposed to the real economy, on the other hand, witnessed a much more modest return.
Regarding US activity, we have finally seen a series of data showing that the economy is finally losing momentum, including negative GDP revisions and a deterioration in the labor market. For this reason, we continue to believe that emerging currencies should perform better against the U.S. dollar.
The election debate in the US has gained a lot of momentum in recent weeks in the light of recent events. This issue is likely to generate a lot of noise in the markets as the outcome and the political and economic consequences are highly unpredictable.
In the local market, we saw a strong detachment from the external environment. The 10-year treasuries yield fall, which was the main driver of foreign flows to emerging markets and Brazil, was not enough to improve the domestic scenario, due to deteriorating fiscal confidence.
The market continues to question the sustainability of Brazil’s accounts, especially with the government’s insistence on correcting the imbalance only through revenue, successively refusing any measure that would cut costs. Moreover, early indications suggest the government is struggling to meet the objectives of its new fiscal framework, showing little propensity for necessary adjustments. Projecting forward, the debt trajectory remains a significant concern.
Although a fiscal and confidence crisis was anticipated, the real economy has yet to fully absorb the impact of currency depreciation and higher interest rates. Contrarily, the business climate diverges from market projections. The economy is still expected to grow by more than 2% this year, unemployment is at historically low levels and banks have been increasing their loan portfolios at a faster pace than last year.
Fiscal vulnerabilities have deepened in capital market dynamics, evidenced by substantial redemptions in the fund industry. The two main reasons for these redemptions are the tax change on closed-end funds and competition with tax-exempt instruments. The foreign capital that was decisive for the improvement in risk assets at the end of 2023 is already showing a significant outflow this year. This strong outflow has caused the Brazilian stock market, especially domestic cyclical companies, to have multiples close to historic lows.
The Brazilian currency was also impacted by this dynamic, showing one of the biggest devaluations among the emerging economies. The interest rate is also one of the highest in nominal and real terms globally – to the point where the real rate is already at 2015 levels, when the fiscal situation was much worse.
In short, we believe that the market has exacerbated the risk premium, detaching itself from economic reality. Over time, we should see a convergence between what the market has been pricing and the real economy. We believe that, over time, assets tend to start pricing in an improvement in companies’ fundamentals, given that we are seeing a government without a majority in both houses and without the backing to maintain a high fiscal deficit.
At the same time, we have pointed out since the beginning of the year that a cooling of American growth and inflation in the United States would help improve asset pricing, and we believe that in the second half of the year we will see a more favorable environment for emerging markets. Domestically, we anticipate that the government will, albeit reluctantly, take steps to reduce the fiscal deficit, thereby stabilizing the currency and yield curve.
Our portfolio remains focused on domestic cyclicals with reduced exposure to commodities. Should the expected compression in Brazil’s risk premium materialize, we foresee greater potential in the first category. The main risk to our strategy is a potential further market downturn that could adversely affect the real economy, although current indicators—stronger credit, robust growth, low unemployment, and controlled inflation—suggest a positive trajectory.
Sincerely,
Moat Capital.
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Past performance does not guarantee future results. Investments in funds are not guaranteed by the administrator or by any insurance mechanism or, still, by the credit guarantee fund. For more information visit the website www.moat.com.br. The fund performances are net of fees, Standard fees are 2% management fee and 20% over the benchmark performance fee