With news Monday that Brazil will impose a tax on foreign purchases of its debt and equity, stocks in the surging Latin American giant have taken a sharp hit. This decline has tempered enthusiasm about the red-hot MSCI Emerging Markets Index, which was up 73 percent year-to-date before Tuesday's outflows from Brazil.
To get a sense of what the new 2 percent tax, which went into effect Tuesday, means for investors with positions in Brazil, U.S. N ews spoke with Josephine Jiménez, manager of the emerging markets fund Victoria 1522. In recent months, her fund has shifted a large chunk of its portfolio into Brazil while dialing back its positions in China because of concern about the country's efforts to slow loan growth. Currently, about 34 percent of the fund's assets are invested in Brazil.
Even with the new tax, which is similar to a 1.5 percent levy that Brazil abandoned last year, Jiménez remains bullish about the Brazilian economy, citing growth stemming from low interest rates. She is also enthusiastic that high concentrations of minerals and strong banks will give Brazil and other surging markets an edge in the foreseeable future.
How has the tax announcement affected your outlook for Brazil?
One should think of the long-term growth potential of the Brazilian economy: The fact that interest rates have fallen significantly, that banks are in an excellent position to finance economic growth because of low loan-to-deposit ratios in the [country], and Brazil has the demographics to support long-term economic growth, particularly in the consumption area. And Brazil is rich in minerals, in natural resources, and as the global economy recovers, Brazil is well positioned to recover because of that. And so this does not change my opinion on Brazil. Brazil used to have [a similar] transactions tax, and other emerging markets countries also have the same taxation; sometimes they just call it a value-added tax. So this is not unique to Brazil, but clearly the market has reacted the way it has today in part [because of] some profit taking. The Brazilian economy has done well, and so with the release of this news, some investors have taken this as an opportunity to raise some cash.
What Brazilian companies do you favor?
I like the banks like Banco do Brasil [and I like] Petroleo Brasileiro. And also we have Cosan, which is a player in the global sugar shortage. It's a well-diversified portfolio. As you can imagine with 34 percent, the stocks we own there are the stocks we love within the Brazilian economy. For instance, there is a property and casualty insurance company called Porto Seguro, and car sales in Brazil have been growing significantly. And with the decline in interest rates, demand for residential and commercial units has also been rising, and so that's good for the property and casualty insurance [industry].
Are there any countries you're avoiding?
We have stayed away from Mexico through most of this year. Initially in the fourth quarter of last year, we had some investments there in the mining industry, but we got concerned because of the significant economic slowdown, because Mexico has free trade with the United States under NAFTA. So of all the emerging markets, it's the one most affected by the U.S. economic slowdown. And we had actually seen Mexico's GDP contract by at least 10 percent, and the market had not done well. Having said that, some of the share valuations could be potentially looking interesting. But we have to balance out also the drug war, and that increases the country's risk profile.
How has the American consumer's reduced purchasing power impacted other emerging markets?
It has affected some countries more than others—for instance, those countries that export heavily to the developed economies. And China had one of the highest ratios in terms of exports as a percentage of GDP. Traditionally for China, that had been close to 35 percent of their economy, and about 20 percent of their GDP is derived from exports to the United States. And so with the economic slowdown in the United States, China had been affected, but China was brilliant in the sense that they implemented a fiscal stimulus package early on.
How will the relationship between emerging markets and the developed world change in the coming years?
I expect that [connection] to be less because of the demographics in America and the other developed markets, wherein those over the age of 50 or 55 are becoming a larger percentage of the population. And so as more baby boomers reach retirement age, their consumption pattern will change.
They'll be demanding less consumer goods through time. . . . They'll be planning more for their retirement; they'll be saving rather than consuming. In the emerging markets, the population is very young, and the banking system is relatively stronger than in developed economies, so the banks have the wherewithal to lend. There's a very strong demand for a lot of goods: automobiles, home appliances, real estate.
What sectors do you like in emerging markets?
The banks, for now and in the foreseeable future. I say that because of the rallies that we have seen globally in the emerging markets. We estimate that there are $360 billion of realized capital gains in the pockets of emerging markets investors based on the average participation of domestic investors and the local trading volume in each of the markets. . . . That's a huge number, [and] part of that will be spent and a part will be saved, and so whatever amount will be saved will make it into the deposit base in the banking system. . . . And also since our theory is that a part of those realized gains will be directed to consumer durables purchases, we've actually been positive about the consumer durables sector, i.e. the automobile industry. . . . But we believe that inflation is going to be rising worldwide, and once inflation is prevalent or before that time, we would be concerned about banks.