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PLANNER REDWOOD ASSET MANAGEMENT MONTHLY COMMENTARY - JANUARY 2018
PLANNER REDWOOD ASSET MANAGEMENT
MONTHLY COMMENTARY - JANUARY 2018
Monthly Commentary – January 2018
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Agenda
Introduction
Economic Outlook
Fiscal Policy
International Outlook
Interest Rates
Foreign Exchange
Stock Market
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Epigraph of the month... a propos of Brazil’s current predicament.
Monthly Commentary – January 2018
“We’re in a political depression – a great political depression.”
Charles David (Chuck) Todd – American Journalist (NBC News).
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Introduction
Monthly Commentary – January 2018
2018 started well in the economy and markets ... even better in politics, will it?
Economic indicators, as a rule, have fared quite well and their reflexes seem to positively "contaminate" the
environment. In the same way and in line with this mood, the financial markets started the year strongly
optimistic, be it in the stock markets, interest or in currency markets. In every market, the exuberance seen
throughout the month points to a likely recovery after years of hardships. However, the question hanging in the
air is: Will it be sustainable? Is it really the beginning of a long-term growth cycle or a plain vanilla "chicken
flight"? The economic policy practiced in recent years, recently reversed, must be resumed before we can
answer this question.
Politics, in turn, already takes center stage at the beginning of the year and has what it takes to be of valuable
assistance along this path of recovery and consolidation of the economy. The year 2018 will be driven by
politics, and a lot at that. The future of Brazil hinges on this, and the conviction of former President Lula in the
Appeals Court, practically disqualifying him from the presidential race, is a sign that we can have an election
with candidates most leaning towards the center and the right. Should this interpretation prove correct, we will
be more likely to have a more liberal, pro-market and reformist president.
Our point is that, with the economy and politics walking side by side, we assume the perception held by economic agents and market players to be more than a
momentary situation, but a vision of structural change. Economic fundamentals are settling down and a virtuous cycle looming, something that can give the
country the possibility to grow, sustainably, for several years ahead. Therefore, it will be of the utmost importance to emerge from this political situation with a
moderate candidate, one in line with the current economic policy, maintaining good economic practices and dissipating the left-leaning ideological bias that,
until the end of 2016, was about to lead us to the Venezuelanization of the country. The President has the power to consolidate the path we are taking now or
to restore the PT era. The quote by the American journalist Chuck Todd that opens this Commentary is very good for Brazil, and we should follow the American
democracy in its basic concept of alternating power, because "We are in a political depression – a great political depression."
Overseas, January was dominated by the World Economic Forum in Davos, the event that annually brings together world economic leaders such as
businessmen, presidents, ministers of State, monetary authorities, IMF directors, World Bank, international organizations, etc. The star this year was US
President Donald Trump, especially for his controversial way of presiding over the world's largest economy, entailing direct effects on every country on the
globe. The results of this meeting, however, fall far short of the best scores since it began in 1971. In any case, the event is an excellent moment to consolidate
the understanding of the new political normal that appears and hitherto little accepted in the world.
In this environment, US Treasuries closed the month at 2.705%. S&P ran at 5.62%, NIKKEI closed at 1.46%, DAX at 2.10% and FTSE, 7.57%. The Ibovespa
ended the month at 11.14% and the IBrX at 10.74%. Monthly highs for DIF19 6.93% and DIF21 at 9.00%. The NTN-B 2050 ended the month at 5.1080%, and
the Dollar (Ptax) at R $ 3.1624.
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Economic Outlook
Source: PIM-PF IBGE| Elaborated by Planner Redwood
Monthly Commentary – January 2018
Manufacturing has finally shown up!
The sector advanced 2.5% in 2017, the first year with any growth after
successive disasters provoked by the industrial policy of Dilma Rousseff's
administration. Capsizing comes from 2014 with 3%, plunging in 2015 and
2016, with 8.3% and 6.4%, respectively. The sector's performance points to
something supposedly consistent, since the IBGE indicates that this
improvement, when compared to 2016, encompasses 19 of 26 sectors
analyzed - with the automotive sector producing 17.2% more than last year
and with more progress, in all production lines.
It is quite difficult not to associate the obstacles to the current recovery with
the failure of PT's industrial policy, couched on downright protectionism,
national-content requirements in goods, and the unrestricted distribution of
fiscal and financial benefits to specific groups. In addition, good news go
further, since the Confidence index of manufacturing depicts a picture of
generalized improvement, with a rises registered in 76% of the 49 segments
surveyed. Is it all well and fine, then? Of course not, the recovery, as it turns
out, has just begun. The consolidation of this movement, as of all other
segments, will depend on the country's economic growth as a whole, as well
as on investments and the opening and modernization of the segment.
The Finance Minister Henrique Meireles seems to understand at this point that the economic recovery on sustainable bases necessarily goes through the
fiscal question and, not least, the improvement of our competitiveness. The Labor Reform alone, for example, is estimated to foster the creation of more than
six million jobs, not only in manufacturing, but also in services, retail, construction, etc. The numerous microeconomic reforms underway also contribute to this
gradual optimism, which makes us, at Redwood, bet on a one-digit unemployment rate as early as 2018.
In sum, once the political question is realigned without retreat of recent economic achievements, we will then witness "strong" growth in 2018, a grace period
for the new president, with Congress "renewed" and therefore with some "courage "to act and, coupled with the good international landscape (for now), a great
window of opportunity to do our homework and prepare the country for a long sustainable development cycle.
Dreaming costs nothing, and in this case it even feels real.
The Great
Disaster
Capital Goods Intermediate Goods Consumption Goods
6
Fiscal Policy
Monthly Commentary – January 2018
The primary deficit surprised, positively.
The data released for 2017, especially when compared to recent developments since the deterioration that became rampant in 2014, is not exciting, but it
brought at least some "relief." Figures stopped worsening, from an expectation of repeating the primary deficit of 2016 at around 2.5% of GDP, ended slightly
below 2%. The table below shows the unequivocal reversal of the expenditures growth rate, which is always quite strongly greater than the revenue growth rate.
We are, of course, far from claiming that this is the trend for obvious reasons tied to the likelihood of economic policy continuity, and we are also far from
meeting requirements to stabilize the debt-to-GDP ratio and even from beginning to build a consistent and sustained surplus path – a shy result, but a good
one, as expectations go.
However, the crux of issue is always the Social Security Reform – the one we need to see voted by any means in February, or else, in the limit, until April. If the
situation does not help to convince society and parliamentarians of the importance of this reform, the possible outside "help" that could come ends up
aggravating matters. That's right, the IMF suggested this month that Brazil should wait a little longer so as to achieve a more "robust" reform. We have
addressed this issue quite often in this report, and we are strictly opposed to such strategy. Neither here, nor anywhere else, under the current circumstances,
will we be able to pass an ideal, complete and finished reform. There is no way out other than to go slowly, with small but constant achievements, and if it takes
3 or 4 steps to do it, so be it. Showing leadership and the constructive vision that we will continue along this line will help to create the conditions, including
those for recovery and commitment to society, to advance in this reform. Postponing it will not provide any solution, and even at the risk of not being approved,
we will have a concrete inkling of the necessity already clear to everyone ... it is simply a matter of pure pragmatism. There is no security or whatsoever that
muddling though until the next government will increase chances of approval. However, we are sure that, next year, this problem will be greater than today.
It's time for unity, courage and definition of responsibilities!
Source: Nacional Treasury | Elaborated by Planner Redwood
BREAKDOWN
% GDP D % GDP D % GDP D % GDP D
I. TOTAL REVENUE 21,1% 3,60% 20,8% 2,15% 21,0% 5,38% 21,1% 5,18%
II. EARMARKER TRASF. TO MUNICIPALITIES AND STATES 3,4% 9,1% 3,4% 3,1% 3,6% 10,8% 3,5% 0,7%
III. NET REVENUE (I-II) 17,7% 2,6% 17,4% 2,0% 17,4% 4,3% 17,6% 6,1%
IV. EXPENDITURES 18,0% 13,1% 19,3% 11,4% 20,0% 7,8% 19,5% 2,4%
V. GOVERNMENT'S PRIMARY SURPLUS -0,3% -122,4% -1,9% 566,7% -2,6% 40,6% -1,9% -22,9%
2014 2015 2016 2017
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(*) https://www.project-syndicate.org/commentary/davos-ceos-tax-cuts-trump-by-joseph-e--stiglitz-2018-02
Monthly Commentary – January 2018
All eyes turned this month turned to Davos - the host city of the World Economic Forum.
Founded in 1971 by Klaus Schwab, the Forum brings together various business and political
leaders, as well as star intellectuals, economists and journalists to discuss the most pressing
issues facing the world, producing various research reports and promoting specific sectoral
initiatives.
This is a high-profile event and, as a rule, many meetings act as catalysts for ideas. While the event
offers a good opportunity for different understandings and perspectives on macro and micro issues,
by deepening comprehension of the views embedded in markets and the minds of opinion makers,
this time the dispersion of assessments seems to have loomed wide.
Perhaps the most compelling voice came from Nobel laureate Joseph Stiglitz, who has attended the event since 1995: "Never have I come away more dispirited
than I have this year." The conclusion of the event itself is not exactly a prime: "No cycle or bull market lasts for ever. Investors will need to weigh risk and
reward carefully”... but the message has been optimistic... “the growing breadth of global growth, gradualist central bank policies and improving corporate
investment are supportive of a longer cycle." Stiglitz himself countered such a conclusion with the title of his article (*): "The CEOs of Davos were euphoric this
year about the return to growth, strong profits, and soaring executive compensation. Economists reminded them that this growth is not sustainable, and has
never been inclusive; but in a world where greed is always good, such arguments have little impact."
One way or another, the year 2018 has started quite strongly in markets (especially in the US), but with some volatility beyond the usual. Corporate performance
is robust and likely to be boosted by tax cuts. Global growth is also projected to have better performance than last year, and risk assessments are now turning to
this "exuberant behavior" that in fact is but a continuation of the trend seen in recent years. There is no shortage of Dr. Dooms predicting disasters in the
beginning of every year .... but it does stand to reason that some correction, even if technical, is necessary.
Although former ECB President Jean-Claude Trichet - and us at Redwood for that matter - think that the Eurozone is now under greater vulnerability (country
indebtedness) than it was back in 2008, the region's economy registered its best performance in ten years, with an increase of 2.5% of GDP. In Asia, China also
surprised positively: it grew 6.9% and its ambitions to become the new world leader increase every day. Following the recipe triggered by the US and then
implemented in Europe, Japan also will quite possibly maintain its policy of aggressive monetary stimulus measures in order to reach its 2% inflation target.
In short, all circumstances (especially geopolitical ones), even the so-called tail risk, seem to have ameliorated. The world scene is very "quiet", including North
Korea recently relaxed extremist stance. Everything too tidy is definitely not usual.
One must distrust such state of affairs.
International Outlook
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Interest Rates
0,0
0,2
0,4
0,6
0,8
1,0
1,2
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
4,5
Evolution of Treasuries (US) and Spread
T-Bill 1Y T-Bond 10Y T-Bond 30Y Spread (30Y -10Y)
Source: Federal Reserve Economic Data | Elaborated by Planner Redwood
Monthly Commentary – January 2018
Using market jargon, one can summarize interest rates in January 2018
through the move that guided the yield curve toward an even more "flattened
out" position. Broadly speaking, spreads between medium- and long-term
interest rates for short-term interest rates have declined, which as "good
economic theory" has it reflects the perception of agents of lower risks for
longer horizons in contrast to those of shorter periods.
But the motives for such a movement have no explanation as simple as it
seems. The first and most corroborating point for this analysis is the general
perception that short-term vertices are already fully priced, as we have
already pointed out (Redwood's macroeconomic projections point to a Selic
rate of 6.75% by 2018, from February, and 7.75% by the end of 2019),
without much room for further reductions, regardless of the model adopted for
assessment. Therefore, Brazil's risk perception has improved, with the
conviction of former President Lula and the growing unlikelihood of his rising
to the presidency in 2018, and with greater relief coming from the
international markets in light of the strengthening of the Real against the
Dollar and the (transient) slowdown in highs enjoyed by US Treasury yields at
the end of the month. Under no circumstances can we expect any "relief" coming from US interest rates, unlikely to occur. US monetary policy tapering under Jerome Powell, with at
least 3 hikes this year, is evident and our models suggest that by the end of 2018 we can have the 10-year T-Bond returns hovering around 3.12% (and close
to 4% by the end of 2019).
This effect of the interest-rate hike by the FED, especially if under grater pace and intensity, is still not properly priced and may cause some bumps along the
way. However, it is nothing that could change the direction of the American economy and even fundamentally affect global markets in the short term. In other
words, we may see some correction (which is healthy, even for markets), but far from having the power to change our current monetary policy.
Our monetary policy, like should any other under inflation targeting regime, focuses specifically on the price level, which is currently well-behaved, that is, within
the target band. However, in the balance of risks, we can not forget the fiscal stance and the mother of all our unresolved problems: social security. The failure
to control public finance seals our fate and puts us back in the realm of higher premiums (interest rates) on the part of investors, especially foreigners. Going
back to market jargon, we can once again see our yield curve under more "steepened" conditions.
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Weekly Interest Rates
NTN-B Diagram Yield Curve Diagram
Monthly Commentary – January 2018
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Foreign Exchange
Monthly Commentary – January 2018
Changes of main currencies against the Dollar Currency /
USD
Closing quote of the month Closing quote of the month Country
November December Change December January Change
Real 3,2681 3,3125 1,36% 3,3125 3,1875 -3,77% Brazil
Euro 0,8401 0,833 -0,85% 0,833 0,8056 -3,29% Europe
Yen 112,54 112,69 0,13% 112,69 109,19 -3,11% Japan
British Pound 0,7393 0,7402 0,12% 0,7402 0,7046 -4,81% Great Britain
Yuan 6,6091 6,5068 -1,55% 6,5068 6,2888 -3,35% China
Rupee 64,4637 63,8725 -0,92% 63,8725 63,5875 -0,45% India
Won 1087,97 1067,4 -1,89% 1067,4 1067,75 0,03% South Korea
Peso 18,6284 19,659 5,53% 19,659 18,5999 -5,39% Mexico
Rublo 58,4322 57,6889 -1,27% 57,6889 56,1922 -2,59% Russia
Lira 3,92 3,7982 -3,11% 3,7982 3,7554 -1,13% Turkey
Rand 13,6981 12,3828 -9,60% 12,3828 11,8514 -4,29% South Africa
Throughout January some facts entailed diffuse effects on
the Brazilian exchange rate. Earlier this month, the S&P
downgraded the Brazilian credit grade to "BB-", while in
the last days of January the conviction of former President
Lula in the Appeals Court and his subsequent
discouragement from running for the presidency opened
some room for the appreciation of the Real. Other
important variables, but not always easily quantifiable for
"composition" of a fair price for the Dollar, such as the
imperative approval of the Social Security Reform (not yet
voted due to parliamentary recess), also gave their
contribution – given the expectation of its likely rejection by
the House – to the depreciation of the Real. At any rate, at
least for now, optimism has won. Albeit a moderate
optimism at that, it looms far from bleak perspectives as
those placed following the downgrade of the Brazilian
rating.
In the first month of 2018, the Real recorded a strong appreciation against the US dollar (-4.40%) in view of the closing of Ptax (Sale) at BRL 3.1624. It was the
largest variation of the month for the Brazilian currency since July 2017 when it appreciated 5.37%. Faced with the undeniable normalization of US monetary
policy, the table below confirms the global weakening of the Dollar in the month, which falls reasonably in line with our projections, except for the currencies of
a few developed countries. In fact, apart from Brazil (assuming the continuity of the reforms), almost all emerging countries should have their currencies
undervalued in 2018 according to our perspectives and simulations.
Financial markets aside, the exchange rate policy does not appear to be altered by the Central Bank of Brazil. Indeed, the BACEN has already "warned" that it
will not change its policy guidelines, and therefore one should expect a mildly active monetary authority, however on standby in case of "necessity." And what
"need" could we be talking about? Brazil's most troubled elections? Any externalities overlooked? It may be so but, coeteris paribus, what we have is a current
account deficit much better than initially expected for 2017 and one likely to be repeated in 2018. The current account deficit and the trade balance will have
significant results in 2018. Direct Investment in the country will grow and foreign exchange reserves will be preserved. These latter make for more than
sufficient reasons for confirmation of the rationale for the defense of the continuity of the exchange rate policy by the BACEN.
In an adverse market scenario due to domestic and external issues combined, however unlikely in the analysis horizon at hand, it is quite reasonable to
assume a strongly active posture by the Central Bank, given the convictions already expressed by its chairman, Ilan Goldfajn. However, for a positive scenario
as we see it at the beginning of this year, we should witness the Dollar tumbling towards BRL 3.00 levels by the end of this year.
Source: Bloomberg | Elaborated by Planner Redwood
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Stock Market
Monthly Commentary – January 2018
In the December report, we discussed the omnipresence of political uncertainties in financial markets and their impact on price setting behavior. Well, with the
conviction of former President Lula in the Appeals Court and his subsequent withdrawal from this year's presidential race, the Brazilian stock market registered
an excellent January for the stock exchanges.
The Ibovespa appreciated 11.14% within the month, the highest monthly increase since October 2016 and the best outcome for the first month of the year
since 2012 with the renewal of its historical maximum (85,530 points on the 26th) largely driven by the return of foreign investors, which had been losing
relative participation. There was a net inflow of BRL 9.5 billion, 53% higher than in the same month of 2017.
The removal of a relevant political risk and the prospect of maintaining the current economic policy, in line with a stronger recovery of economic activity than
originally expected by a fair share of the market, had and still possibly have the necessary strength to boost the shares of Brazilian companies. Considering
that recovering consumption scores and the fall of interest rates and corporate financial leverage provide a "structural fuel" for this movement, the trend is that
(apart from possible short-term fluctuations) the Ibovespa's continues to climb. From a price/earnings perspective, it is possible that the index exceeds 100,000
points by the mean-reverting principle - but, there is no denying that prices are historically very high ... above, indeed, all other metrics used in the chart below.
That being said, are we walking into, what the wizards call, a bubble? The rapid increase in asset prices raises red flags and makes for a fundamental part of a
bubble ... it is quite difficult to escape the theory of efficient markets, but without dismissing (at least for the short run) the behavioral (and irrational!) effect of
the various players of the market. The fact is that assets can be cheap and remain cheap for long, or, similarly, expensive and increasingly expensive, making
it hard for many to keep away from the flow. Real investors need to have a lot of patience and do their math - all the time.
DISCLAIMER
This material has been prepared by Planner Redwood Asset Management Administração de Recursos LTDA. (Redwood) and is for
information purposes only and does not constitute a recommendation for investment, offer or solicitation of an offer to acquire
securities or any financial instrument. The information, opinions, estimates and projections refer to the present date and may
contain information about future events and these projections / estimates are subject to risks and uncertainties related to factors
that exceed our ability to control or estimate accurately, such as market competitive environment, fluctuations of currency value and
inflation, changes in regulatory and governmental entities, a well as other aspects that may differ materially from those projected
without prior notice. The information herein contained is based on the best available information collected from public, official or
credible sources, which we believe to be reliable and of good faith. However, they have not been independently verified and,
neither express nor implied warrant is given as regards their accuracy. We are not responsible for any omissions or errors, and
even as we have taken all precautions to ensure that the information contained herein is not false or misleading, Redwood is not
responsible for its accuracy or completeness. The opinions expressed solely reflect our opinions at the moment. We reserve the
right at any time to buy or sell such securities. These projections and estimates should not be construed as a guarantee of future
performance. Redwood undertakes no obligation to publish any revisions or update such projections and estimates in light of
events or circumstances that may occur after the date of this document. This material is provided for the exclusive use of its
recipients and its contents may not be reproduced, redistributed, published or copied in any form, in whole or in part, without the
express permission of Redwood.
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