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In the recent meeting between the presidents of the United States and Brazil, Obama informed Lula that he would one day like to visit the Brazilian beaches and the Amazonian forest. The general misconception is that Brazil is merely a vacation destination with nothing more to offer than samba dancing and soccer games, whereas in fact, this country offers a great deal of diversity with various investment options. This article will look at four ways to participate in Brazil’s growth over the next few years in step with developments in the global economy.

The global crisis can be divided into four phases: a liquidity crisis which halted the flow of capital between financial institutions, a financial crisis in which stock markets collapsed and banks failed, an economic crisis marked by unemployment and low earnings and an inflation crisis, which is likely to occur as a result of the actions taken by world governments in response to the three earlier crises. Each of these global shocks has had (or will have) an indirect effect on Brazil and opportunities arise as a result of each phase.

The earlier “acts” in this article are investments that can be profitable in the short-term whereas the later ones are more appropriate for a long-term horizon.

Act I – Fixed Income

The Brazilian interest rate is at 11.25% which is notably higher than the rates set by the U.S. Federal Reserve or the European Central Bank of 0%-0.25% and 1.5%, respectively. To benefit from the high Brazilian interest rates an investor must be willing to accept the currency risk associated with holding the Brazilian Real which is over 30% off its high of last summer. The downturn in the Real has been a combination of risk aversion and forced liquidation which drove foreign investment back to home currencies, as well as a reduction in demand for commodities. The market’s appetite for risk should return in the near-term as government programs reinforce confidence and the commodities market should also expect a rebound in the long-term as discussed below.

The window on this opportunity is closing as the Brazilian Central Bank continues to cut rates. Just in the last month, they cut the overnight lending rate by 1.5%. Yet it remains far higher than what can be expected from other countries and well above the current Brazilian rate of inflation of approximately 6% (which continues to diminish). The Real has also strengthened recently as the Geithner plan reduces the level of overall fear. This rally may be temporary but over time one can expect the Real to continue its positive ascent. As Act I begins to wind down, other opportunities are emerging in Act II.

Act II – Banking Stocks

The financial sector was at ground zero of the crisis causing banking stocks to be among the first hit and most damaged. Brazilian banking stocks, such as Itau and Bradesco, could not avoid the contagion effect as they too suffered from diminished liquidity and a stagnating economic environment. Itau is now trading below $12 and Bradesco trades under $11 (both approached $26 last summer). But it would be inappropriate to place them in the same lot as U.S. or European banks since the underlying fundamentals of Brazilian banks are generally intact as their balance sheets are free of toxic assets. Brazilian banks are better capitalized than their U.S. counterparts and generally healthier as a result of banking reform in the 1990s. Itau recently announced a merger with Unibanco, making it the largest Latin American bank with the potential to become a global player.

The measures taken by governments worldwide to rescue banks may soon result in a bottoming of the financial crisis. The shares of Itau and Bradesco should benefit most from such a recovery as they are among the healthiest financial institutions and were indirect victims of the crisis.

Act III – Consumer-Oriented Stocks

Many emerging markets are currently suffering because of their dependence on exports to the United States and other developed countries. Economic recovery of these export-driven nations cannot begin in earnest until the developed markets to which they sell recover as well. Brazil is in a unique position among developing countries in that it has a large internal market and a growing consumer class. Currently the Brazilian middle class (referred to as class “C”, with R$1,115 to R$4,807 in monthly revenue) grew nearly 4% between August and December of 2008 (primarily at the expense of lower-income classes). This increase occurred despite the drop in the Brazilian financial markets.

Unfortunately, not many Brazilian ADRs offer access to the middle class consumer market. Most of the pure plays are limited to the Brazilian stock market, including retailers such as Lojas Americanas, Pau de Acucar and Globex Utilidades.

The growth in Brazilian consumption will be temporarily curtailed as unemployment has recently increased nearly 2.5% percentage points to 8.2%. However, the Brazilian consumer should be more resilient than others and the growth of the middle class is a trend that will continue to evolve over the next several years. As the crisis continues to bring down the value of Brazilian consumer oriented companies, these stocks will become increasingly attractive in the mid-term.

Act IV - Commodities

The drop in worldwide demand for commodities has been one of the dominant factors that brought the crisis to Brazil. Unlike banking and consumer-oriented stocks, significant increases in commodity prices will be more dependent on a recovery of the global economy which many economists do not expect until 2010. As noted above, an inflation crisis may be imminent as many countries increase the money supply to stimulate their economies. A decline in global currency values will result in an increase in commodity values relative to those currencies. Moreover, the drought in investment activities has halted expansion projects of commodity producers. As a result, the capacity to provide additional supply will be unavailable once the economy recovers. Brazilian commodity producers such as oil company Petrobras (NYSE:PBR), mining giant Companhia Vale Rio Doce (NYSE:RIO), steel producer Gerdau (NYSE:GGB) and sugar/ethanol producer Cosan (NYSE:CZZ) should all benefit from the rise in commodity prices.

Since the inflation stage of the crisis is still well ahead of us patience is required for these investments. One option to reap more immediate rewards is to invest in debt securities issued by these companies.

Epilogue

Brazil is not immune to the global crisis, yet it is likely to pull out of it quicker and more robustly than most other nations. The 1997 Asian crisis had a devastating impact on emerging markets but only slightly injured developed economies. The current crisis may play out in an inverse fashion with developed countries experiencing the worst and a handful of emerging economies coming out on top.

Just as the 1997 crisis provided a buying opportunity in the developed world’s financial markets, this crisis is doing the same for Brazil. The liquidity crisis reduced interest rates and caused a flight to the dollar which made Brazilian interest rates comparatively higher and the Real cheap. The financial crisis brought down otherwise healthy Brazilian banks and the economic crisis is providing a unique entry point to reap the benefits of Brazil’s growing consumer class. Down the line, the upcoming inflation crisis will bolster Brazil’s commodities companies. Currently, we are on the tail end of Act I and entering Act II but the biggest upside potential may lie in Acts III and IV.

Disclosure: Author holds positions in BBD, ITU, CZZ, RIO, GGB

Source: Four Ways to Invest in Brazil's Growth