We set out to determine whether Brazilian sentiment factors could add value to an analysis of the Brazilian economy. Specifically, can sentiment help forecast the direction of volatility, currency, stock index, and fixed income prices in Brazil?
In this report we provide evidence that current sentiment on Brazil is excessively bullish. In summary, both currency and stock market valuations are susceptible to negative shocks and are likely to underperform over the next year relative to the United States. Furthermore, we see that our manufacturing activity model for Brazil shows softening in April and through the first two weeks of May 2013. As references, please see the Brazilian Real ETF, BZF and the Bovespa ETFs (both long and short): EWZ, FBZ, BRF, BZQ, and BRAZ.
The Innovations that Underlie Our Sentiment Analytics
The analysis featured in this paper was facilitated by four innovations in software technology.
- Natural Language Processing. Advances in linguistic analysis allow high resolution detection of specific economic concepts and sentiments in text. We have a patent pending on our unique style of analytics which extracts granular sentiments including emotions and macroeconomic opinions.
- Cloud Computing. Our statistical models take advantage of massively parallel computing systems including the Amazon EC2 Cloud.
- Big Data. Merging cloud computing with natural language processing generates hundreds of terabytes of sentiment data about tens of thousands of topics. This data can be efficiently processed using MapReduce software architectures.
- Predictive Analytics. Statistical analysis software has advanced dramatically in the past decade. Predictive modeling on complex, seasonally-varying, and non-stationary time series is now possible.
We use the above innovations to generate statistical models of global economic activity.
The Outlook for the Brazilian Real
We identified several sentiment and macroeconomic factors of interest surrounding the Brazilian Real (BRL). In particular, we see an extremely positive consensus outlook for the BRL versus the USD and increased chatter about the BRL in the carry trade.
Based on our quantitative studies of forecasting currency and equity prices with sentiment, we see that our variables PriceForecast, Optimism, and MarketRisk have high correlations with future 12-month returns. The following sections will examine these variables for the BRL.
Consensus Price Forecast of the BRL
Consensus Price Momentum of the BRL
Consensus Price Momentum for the BRL is high.
Discussions of the BRL and the Carry Trade
BRL Currency Summary
In our data currencies tend to continue trends in the short term but reverse in a contrarian manner in the longer-term Given the high recent price forecast, price momentum, and carry trade discussions around the BRL, there may be a short-term rally, but in one year the value is likely to be lower. That is, BRL/USD long term outlook is weakening.
The Outlook for the Bovespa
Sentiments that drive stock index valuations differ from those that drive currencies. Stock indices are more susceptible to contrarian pressures over both the short and long terms.
The Bovespa MarketRisk Index
The following image demonstrates that the MarketRisk index for the Bovespa is near its highest level since 2008.
Bovespa Optimism Is Near 12-Month Highs
Optimism is high for Brazil and the Brazilian stock indices.
Bovespa Fear Is At 12-Month Lows
Based on our research, equity prices tend to respond to sentiment in a contrarian manner over the long-term (12-months). The Bovespa is down 11% so far in 2013, yet optimism is high. Such a paradoxical situation often occurs when a super-cycle or bubble is ending, as participants with vested interests beat the drum of enthusiasm in order to gain social and psychological support for their own bullishness. Such high optimism indicates a state of denial by current Brazil investors, and a continued decline is likely until they are washed out. Given the relatively low fear and high optimism surrounding the Brazilian market, we see a continued weakening of the Bovespa versus developed world equity markets over the next 12-months.
Brazil's Macroeconomic View
In the following chart we plot the Bovespa from 2010-2013 versus two variables: "Fiscal Policy Loose Versus Tight" and "Monetary Policy Loose Versus Tight," where the positive y-axis represents both stimulative fiscal and easy monetary policy. The red line represents fiscal policy, while the lavender represents monetary policy.
There is no clear conclusion to be drawn from this chart for current conditions. However, going forward, if both fiscal and monetary tightening are anticipated, an accelerated downturn in the equity market is likely.
The Outlook for Brazilian Economic Activity
We developed daily-updating economic activity indices for each of the G-12. In the following section we discuss real-time economic activity estimates in Brazil.
Brazilian PMI Falling in May 2013
Global traders, economists, and central bankers watch monthly Purchasing Manager's Index (PMI) releases with keen interest. While the PMI releases contain mission-critical information about economic activity, they are infrequent, being delivered only once per month.
In economic modeling of Brazil, we see that EconomicGrowth, Sentiment, Uncertainty, ConsumerSentiment, Joy, Violence, and GovernmentCorruption create the best fit for past PMI-based economic activity in Brazil. The Brazilian simulation of PMI we created allows us to predict future PMI values with daily updating frequency based on the latest news flow.
A global view is available. See Brazil's data as the lowest row in the image:
Note that Brazilian PMI estimates are falling on a monthly level, but rising on a weekly level. Below the global view is a tabular view of our daily estimates, which show a declining Brazilian PMI value as of May 16, 2013.
In summary, the Brazilian economy continues to slow in May 2013, as will be reflected in the end of month PMI number.
The Brazilian economy continues to weaken into May 2013 based on our real-time economic model. Additionally, we see unusually high optimism about both the Brazilian equity and currency markets despite recently stagnating values. Likely to witness a decline in Brazilian Real ETF and the Bovespa long ETFs and versus the U.S. markets and currency. Positive sentiment in a falling market, one that was formerly very bullish, represents wishful thinking of a recovery. Such optimism indicates that the declines are likely to continue over the next 12-24 months, until they climax in a reversal of sentiment to extreme negativity and a price capitulation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.