MorningWord 9/24/15: Brazil Waxed

by Dan September 24, 2015 9:33 am • Commentary

If the last 20 years have taught investors anything, it’s that economic and market shocks are very unlikely to remain contained to their region of origin.  For better or worse the global economy is an intricate web with the strong pulling up the weak and the weak pulling down the strong. Over the last couple decades, when a crisis hit a major risk asset class in a specific country or region, it has been nearly impossible to avoid some sort of contagion. See Argentina and Brazil in the 1980s/1990s, Russia and Asia in the late 1990s, U.S. credit crisis in second half of the aughts, the European Sovereign Debt crisis of the last few years, China’s economic slowdown of the last few years, and now Brazil seems to be the number one economic trouble spot on the globe.

Let’s focus on the last two.  For all intents and purposes there is no crisis in China, the country is merely dealing with some massive secular shifts in their centrally planned economy as they position for more normalized growth.  But the reverberations of this slower growth have sent ripples through the rest of the global economy.  I know that you know all of this.  But I guess what I want to key on is if you have only been watching China’s data and the fluctuations in their currency, credit markets, commodities and their stock markets then you are likely missing what will be the origination of the next financial crisis that poses systemic risk to your much loved (and perceived safe) U.S. equity holdings.

Some very smart market participants and astute market pundits have been speaking of the impending economic implosion in Brazil for some time. So I don’t mean to be a Johnny Come Lately. Regular readers know that macro is not the main focus here. But where I think I can add value is understanding the shift in sentiment among different macro issues and how it may impact what we are doing here in the U.S. on the micro.  So Brazil imploding seems to be hitting a fever pitch, and if you are just now trying to get your arms around the implications, I think its safe to say you missed a big chunk of the macro trade and it’s now a bit of an adult swim.

China’s slowdown helped ignite the commodity implosion that is upon us, and the knock-on effects in countries like Brazil have been sick, with the real at new all time lows vs the dollar and their 10 year treasury yield up 400 bps in the last month to over 16%.  Jim Cramer has called the (sort of) government owned Petrobras (PBR) the “world’s biggest problem“. And Brazil has a full on political scandal linked to their sitting president who was a board member of PBR when the fraud took place and has now become both a political and economic hot potato.   I guess Cramer’s point is more a question… what would be the implications of some sort of socialization of PBR’s debt (after an increasingly likely default), more than 5x its current equity value of $23 billion under dramatically distressed political and economic conditions??

I am not smart enough to have an answer to all these questions. In the not so distant past it was an unfathomable possibility, but now it’s looking likely that their will have to be a painful reorganization of PBR’s debt. I can assure you if and when that happens, we would be amid a new economic reality at a time when global financial markets are the most fragile they have been since 2008.