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March 27, 2005 8:14 pm
There seems to be no stopping Brazilian companies in their rush to go public.
Seven made initial share offers last year - not much by some countries' standards, but the biggest burst of activity in Brazil for a decade. Most were well-regarded companies such as Natura, in cosmetics, ALL, in transport logistics, and Gol, a low-cost airline. Several more, including Magazine Luiza, a successful chain of household goods stores, and Folha-UOL, a powerful newspaper and internet group, are preparing to follow. Gol is already preparing a second issue.
Most have gone well. Porto Seguro, an insurer, and Diagnósticos da América (Dasa), a firm of medical laboratories, both opened their capital on November 19. The main market index, the Ibovespa, has risen by about 10 per cent since then; Porto Seguro is up 40 per cent and Dasa, 50 per cent. The first to market, Natura, on May 26, has doubled in price, against a 40 per cent rise in the Ibovespa.
But there have been jitters, too. Shares in Grendene, a footwear manufacturer, have fallen by 30 per cent since their launch in late October compared with a 16 per cent gain for the Ibovespa. The single issuer to date this year, Renar Maças, which grows apples for export, has lost 14 per cent since launch on February 28, against a 6 per cent slide in the Ibovespa.
Is there a leak in the Brazilian bubble? Some market players think they hear hissing. “This is one of the longest bull markets ever for Brazilian equities,” says one investment banker in Sao Paulo. “Right now people will buy anything. But you only need one or two losers and that money will be gone.”
Renar may be a particularly unfortunate case. It was a modest issue, raising R$16m (US$5.9m). Many buyers were Brazilian retail investors, the kind the Sao Paulo Stock Exchange, the Bovespa, has worked hardest to attract. But they are also the most fickle. Many have found they haven't the stomach for the Bovespa's notorious volatility, and may be hard to coax back.
There are other warning signs. During February, when investors expected no sharp tightening of US interest rates, foreign money flowed into Brazilian assets in search of high returns. The Bovespa recorded a net inflow of US$3.7bn, more than twice the biggest monthly net inflow during 2004. With US interest rates now heading resolutely upwards, those flows have begun to slow. “I wouldn't say we're seeing [capital] flight,” says Caio Bastos of Fair Corretora, a Sao Paulo brokerage. “But anybody who was thinking of bringing more money in is thinking again.”
Equities, accordingly, have taken a dive. The Ibovespa gained 16.9 per cent in dollar terms in February but lost 9.3 per cent in the first 22 days of March. The currency, which usually rises as equities fall and vice versa, has instead fallen in tandem, losing 6 per cent against the dollar since mid February. The price of Brazil's benchmark sovereign bond fell 4.4 per cent over the same period. This month, the central bank cancelled a weekly domestic bond auction because of “excessive volatility”.
Put all this together and it sounds like trouble, especially against the recent background of GM's profit warning and ratings downgrade and the sell-off in emerging market and high-yield bonds. As ever when nerves are rattled, Brazil has been among the first to suffer as the high liquidity of its assets offers easy escape. “It's not a case of everybody out,” says Nami Neneas, head of equities trading at Banif Investment Bank in Sao Paulo. “But Brazil is again becoming the way out of emerging markets and into more secure assets.”
Is it time to panic? Mohamed El-Erian of California-based asset manager Pimco, usually one of the coolest heads in a crisis, thinks not. He argues that activity in Brazil and other emerging markets is a typical reaction to an external shock - in this case, a periodic market repricing that is normal in a world where non-commercial buyers (ie central banks) are the marginal price setters.
For this to turn into something worse, he says, three things must happen. First, bad technicals must deteriorate into bad credit fundamentals - for example, if Brazil were forced to borrow at ever higher costs to cover spiralling floating-rate domestic debt. Mr El-Erian thinks this won't happen because Brazil and other countries have hefty foreign reserves to act as circuit-breakers.
Second, long-term investors would have to start selling. “The only people selling now are hedge funds going short to credit markets and some retail investors,” he says. Institutional investors are staying put. In fact: “For Brazil, people are looking more to buy than to sell.” But he admits this is something that requires close monitoring. His third trigger would be a setback to the global economy and consequent rise in default risk. This could be caused by an asset price collapse, or if central banks decided no longer to finance the US current account deficit. He thinks neither event is on the horizon.
The problem, he says, is that price makers such as hedge funds take a top-down rather than bottom-up view. In such circumstances: “Valuations start getting out of whack with realities. The [Brazilian] real is depreciating at a time when surpluses are big, reserves are rising and flows are coming in. But nobody cares.”
Brazil's fundamentals, indeed, are strong. The economy grew by more than 5 per cent last year and should grow by at least 3.5 per cent this year - not great, but better than the 2 per cent average over most of the preceding decade. Exports are powering ahead on global demand for Brazilian commodities such as iron ore and soya. Banks and big companies are making record profits.
The profile of public debt has improved greatly, with longer maturities and less dollar-linked paper. Investors still want a taste of Brazil's high interest rates, and they still want new plays on the domestic economy. The new issues will keep on coming.
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