Brazil is in turmoil.
What started out as anger over higher prices for public transport and the cost of the World Cup has turned into more general protests.
To an extent, the country has been a victim of its own success. The growing ranks of the middle classes have come to expect a better life, and are now also in a position to demand it from politicians.
So is it all set to go horribly wrong for what was once one of the most promising emerging markets?
It could, there’s no denying that. But in truth, we think this is more likely to be a decent buying opportunity for long-term investors. Here’s why…
Brazil is in better shape than you might think
It’s easy to see why the average Brazilian is feeling unhappy.
After a decade in which living standards grew rapidly, growth has slowed. China’s slowdown could easily make things worse, and may even pitch Brazil into a recession.
At the same time inflation remains a serious problem, running at 6.5% a year. This combination – low growth and high inflation – means Brazil is afflicted with the dreaded ‘stagflation’.
Stagflation is a tricky economic beast to deal with. The cost of living is rising as prices head higher. But wages are also being squeezed because growth is weak. This means consumers are seeing their standard of living decline daily.
It also makes things very difficult for the central bank. The usual central bank remedy for low growth is to loosen monetary policy, and make it easier to borrow. But the usual remedy for high inflation is to make it harder to borrow. So the Brazilian central bank is damned if it does, and damned if it doesn’t.
Throw in corruption and poor public services on top of this, and there’s a lot of potential for discontent.
However, it’s important not to get carried away. It’s easy to paint this as part of a global wave of revolution – a sort of ‘middle class spring’.
But Brazil is not Egypt – or even Turkey. It’s been almost 30 years since the military was last in power, and the nation’s basic democratic institutions (the press, parliament and the courts) are strong.
For their own part, the protestors merely want the government to listen to their demands – they’re not looking for major political change. This isn’t revolution – it’s an angry memo to the management.
So the chances of a coup, prolonged chaos, or a Hugo Chavez-style strongman emerging from this are next to zero.
The government also has a lot of room to manoeuvre on the fiscal front. At the moment, Brazil actually runs a small budget surplus, which means that it takes in more than it spends. This means it could safely pacify the protestors by cutting taxes and increasing spending, if necessary.
Even the commodity story also isn’t as bad as it seems. China’s slowdown will clearly hit the likes of Australia and Canada hard, as their exports of raw industrial materials have fewer buyers.
But the good news for Brazil is that more than a third of its exports are in the form of agricultural commodities. These are much less dependent on Chinese demand.
Another big chunk comes from energy. Again, this is less China dependent than copper, for example. While shale oil and gas may push prices down a bit in the medium term, they have been pretty resilient so far, and have actually risen in the past few weeks.
So overall, the Brazilian economy may well do better than many people currently think amid the big rush to offload emerging market and commodities plays.
These protests could help Brazil get its act together
The protests should also encourage the government to spend more money on infrastructure. As we’ve noted in the past, getting goods and crops around this vast country is incredibly difficult.
That’s because, as well as being a huge country with lots of very rural areas, Brazil’s roads, railways and ports are on a par with those of some of the poorest countries in the world. The situation is so bad that if the state made anything like a concerted effort, many of these projects would rapidly pay for themselves.
Even before the recent anger, the government had signalled that it was going to invest money in upgrading its transport network. Last year, it detailed a $66bn stimulus package. It is also trying to encourage foreign investors to pitch in by providing tax breaks, subsidies and guarantees.
And transport is not the only element of infrastructure that needs to be improved. A recent report by the accountancy firm PricewaterhouseCoopers suggested that the amount of electricity generated must double over the next 30 years, to prevent power shortages.
How to buy into Brazil
But perhaps the best reason to buy into Brazil is that it now offers good value. Even before the events of the past few weeks, it was one of the cheapest markets in the world when set against long-term earnings.
The recent price falls mean it now trades at just 9.6 times forward earnings. This is not the only sign that investors are being too downbeat. The Brazilian index also trades at a 10% discount to its book value. This means that firms are now worth less than the land, property and other assets that they hold, even when debt is taken into account.
The simplest way to buy Brazil is via a tracker fund, such as the iShares MSCI Brazil (LSE: IBZL). A riskier, single-company option, is to buy CPFL Energia SA (NYSE: CPL). CPFL is the largest private energy company in Brazil. It both generates and distributes energy in the major industrial centres. That means it should benefit from rising electricity demand. At the moment revenue is growing by 10% a year. While it trades at just under 15 times forward earnings it offers a high dividend yield of more than 6%.
Also, if you’re interested in Latin American stocks, you should sign up for our free newsletter, The New World. Every week, my colleagues James McKeigue and Lars Henriksson look for the most exciting opportunities in South America and Asia.
• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.
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