Letter to investors – 3rd quarter 2019
Dear shareholders,
The third quarter of the year was very intense for the markets. The global economy and, in particular, the United States had a notable worsening of its economic growth indicators. Nevertheless, a series of geopolitical events – China x USA, Brexit, conflicts in the Middle East and Trump’s impeachment – have made the reading of the external scenario even more complex.
The main debate among local investors is about when (and if) the world will go into recession, its magnitude, and mainly, if this will be enough to undermine the recovery of Brazilian activity, compromising the companies’ earnings growth capacity.
Falling manufacturing indicators around the world and the growing dispute between China and the US reduce expectations of global growth (interestingly, Brazil and Greece led the industrial production ranking in September). The direct effect for Brazil was reflected in commodity prices and the appreciation of the dollar.
On the other hand, we observe a coordinated move by almost all central banks to loosen monetary policy, which should favor, in the short term, a reduction in the growth differential of emerging markets versus developed countries.
Despite the uncertainties, Brazilian stocks exposed to the global growth cycle, such as commodity exporters, already have a major deceleration in the prices of their products. In addition, these companies, for the most part, are going through a cycle of low investment and large cash generation. Thus, we understand that if there is no recession in the short term, there is a great positive asymmetry in these assets.
With regard to the Brazilian economy, a consensus was formed that we are facing a reasonably benign scenario regarding inflation and that the BC may stimulate the economy by leaving the real interest rate at very low levels. However, there is also a strong consensus that the economy will not grow in the coming years, even with this extremely stimulating monetary framework.
We disagree with this market consensus that growth will not accelerate. Without entering into the debate on how much the complex global scenario described above can worsen agents’ expectations, we see a very favorable context for increasing the speed of growth in Brazil, even if it is still late.
We mentioned in previous letters the consequences of the country experiencing historically low nominal and real interest rates. This scenario was consolidated throughout the second quarter; and the advance of the reforms, although less than ideal, consolidates the country in a controlled trajectory of its accounts – the CDS (index that measures the country risk) of Brazil is close to the historical minimum.
Allied to the fiscal adjustment, the thematic agenda is showing clear signs of progress. PL79, which improves the telecommunications regulatory framework, was enacted, the sanitation regulatory framework continues to pass through Congress, among other measures to improve productivity that are being debated. We will have a big round of road and airport concessions. Probably in November we will have the biggest auction of oil exploration rights in the world. It is indisputable that the country offers better opportunities for companies’ profit growth.
For these reasons, we are highly convinced that the economy should accelerate its growth at some point in the future and companies’ profitability should increase at an even greater pace.
We can see some sectors and companies that are already starting to incorporate this more promising scenario into their prices. Therefore, currently the selection of companies is fundamental.
Often a company with an attractive and very popular history can be a low-return investment and, at the same time, a company with little short-term perspective can be an attractive investment.
It is important to emphasize that the asset price level incorporates, to some extent, the maintenance of interest rates at low levels. This situation depends on the progress of the fiscal adjustment. Thus, over the next few months, the market should remain sensitive to political news.
In summary, we remain confident with the progress of reforms and the secondary effects of the monetary easing underway in the country. External risks seem to us to be relatively embedded in expectations, and consequently, in stock prices.
