Brazilian Real gains more value in 2019 than any other currency

In this week’s issue: Brazilian Real gains more value in 2019 than any other currency. Are foreigners short-selling Brazil’s stock market?

The week in review

• Embraer. President Jair Bolsonaro gave the greenlight for the Boeing-Embraer merger. The two companies will create a joint venture (of which the American planemaker will hold an 80% stake). The deal will not involve Embraer’s defense nor executive jet divisions. This piece of news pushed Embraer’s stock up 2.57%, but S&P has threatened to downgrade the company. The ratings agency believes the deal will weaken the company and its credit quality, due to the higher volatility of future profits.

• Venezuela.President Nicolás Maduro was inaugurated for a third consecutive term this week. Workers’ Party’s chairwoman Gleisi Hoffmann went to the ceremony, while the Jair Bolsonaro called Mr. Maduro “illegitimate.” The Ministry of Foreign Affairs said that the country’s Congress (which has questioned the president and declared its Speaker the interim president) is the institution that really should detain power.

• Inflation.For the second straight year, Brazil’s official inflation rate finished the year below the target set by the Central Bank. In 2018, prices rose by 3.75% (against a 4.5% target). Low inflation should allow the Central Bank to keep the Selic benchmark interest rate at 6.5%, its lowest ever. Analysts forecast that the rate should only go up by the end of 2019—or in 2020—in order to stimulate consumption and investments.

• Violence.The violence spree tormenting the state of Ceará since January 2 continues. This morning, criminals took down a power transmission tower and exploded a bomb in a car dealership. The Ministry of Justice has reported that since the beginning of the attacks, 35 members of criminal gangs have been transferred from local prisons to federal penitentiaries.

• Diplomacy.Just over a week in office, Ernesto Araújo has made his first big move to defeat “cultural Marxism” by withdrawing Brazil from the United Nations Global Compact for Migration, signed by 164 countries in December of last year. “Brazil has the sovereignty to decide whether or not it accepts migrants,” declared President Jair Bolsonaro, also stating that anyone moving to Brazil “must sing our anthem and respect our culture.”

• Economic recovery.In 2018, savings accounts (the most popular investment in Brazil) saw a net gain of BRL 38.2bn, the best result since 2013 (before the start of the worst recession in the country’s history), when Brazilians had injected BRL 71bn. The trend points towards a recovering economy—albeit a slow one. Analysts project that Brazil’s GDP growth last year was 1.3%.

Brazilian Real gains more value in 2019 than any other currency

No currency has gained more value against the U.S. Dollar this month than the Brazilian Real — when compared to 143 other currencies. Analysts, however, doubt that this will be sustained, unless President Jair Bolsonaro promptly implements the pension reform. Or, at least, that his administration shows “concrete progress” towards these reforms, according to Win Thin, a strategist for emerging markets at investment bank Brown Brothers Harriman (BBH). Germany’s Commerzbank evaluates that the goodwill towards the administration is already in the currency ‘s price — for further evaluation, real change will be needed.

Are foreigners short-selling Brazil’s stock market?

In 2019, the São Paulo stock market has risen 6.57%—the second-best performing market, trailing only Argentina’s Merval index. Still, one thing has worried some analysts: foreign investors keep increasing their short position in the Ibovespa futures market—which is seen as a bet that the main index of the Brazilian stock market will plunge.

Short positions amounted to 165,000 contracts this week—the highest level in 14 years—as pointed out by Moises Beida, manager at investing company SRM Asset. That mirrors what local investors are doing, which is buying Ibovespa futures (158,000 contracts).

However, that doesn’t necessarily mean that foreigners are betting on there being problems with the stock market. Investor David Cohen, from Paineiras Investimentos, explained another way to read this trend. Mr. Cohen explains that what drives the price of an asset is if the will of a buyer to pay more is higher than the will of the seller to get rid of the asset. In that way, if local investors (who have been the driving force of the Brazilian stock market in the wake of the Jair Bolsonaro wave, as reporter Mario Braga explained on January 1) are buying everything, it makes sense for foreigners to sell their positions.

One way to read the chart above is: foreigners are selling their positions on Ibovespa futures when the stock market is high in order to make more money. It doesn’t necessarily mean that they are betting against Brazil’s market.

Mr. Cohen looked at the size of foreigners’ portfolio in stocks — about BRL 1.185 trillion, against a short position of BRL 12.6bn. Between January 2016 (when foreigners’ positions in Brazil were at an all-time low) and the end of 2018, the portfolio of investors not residing in Brazil increased by BRL 644bn. Such an increase is due to a spot market flow, variation in futures contracts and an impact caused by valuation (share valuation is done based on quantitative techniques and share value will vary depending on the market demand and supply).

A large initial investment of capital (flow) could become relatively small (stock) in the case of significant currency depreciation. That’s why the Institute of International Finance reported that Brazil is the emerging market with the lowest position of foreign investors.

But what could be happening with foreigners’ positions is merely an adjustment due to an improved valuation.

The reaction of VP Hamilton Mourão—who has enormous prestige among the Armed Forces’ top brass—is telling, for the lack of support he has shown. “I’ll wait for his clarifications before commenting on the case.” Military advisors also defended that Flávio Bolsonaro own up to the case in order to preserve his father’s government.

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