US investors face many challenges: a highly-valued stock market, low interest rates and quantitative dis-easing. But, investing is easier in the U.S. compared to many smaller economies.
The Brazilian market is an example of how economic complications from inflation and currency devaluation can create big investment problems. These problems are real for Brazilians, but also relevant to U.S. investors who are concerned about the effects of inflation on their investments.
In many ways, Brazil has one of the worst saving and investment climates in the world. Here's why.
A Declining Stock Market
As shown in Figure 1, since 2011 the S&P 500 is up 47.85%. During the same time, the Brazilian Bovespa is down 32.0%, a commutative difference of 80%. The Brazilian market declined even with a small tailwind from US quantitative easing sending money into Brazil and other emerging markets.
Figure 1: The US S&P 500 vs. Brazilian Bovespa 2011-2014
To find better returns, Brazilians must consider investing outside their country. To do this they will need to invest in a foreign currency, which presents their second problem - an actively devaluing currency. Since 2011, the Brazilian Real has moved from R$1.4 per dollar to R$2.2 per dollar (see Figure 2). This devaluation makes buying foreign investments increasingly more expensive.
Figure 2: The amount of Brazilian Real required to purchase one U.S. Dollar.
Currency devaluation is connected to a third problem, high general inflation in the domestic economy.
American investors speculate about inflation, and often worry it will return, but in Brazil they don't need to speculate. They have had to live with inflation for decades. As shown in Figure 3, Brazil has averaged near 6% inflation for the last five years. In 2005 it was 14.78 percent, near historic highs for the United States.
Figure 3: The Brazilian Consumer Price Index
During the same 2011-2014 period that the Brazilian stock market declined 32% the currency inflated 24%. So not only did Brazilian investors, as a whole, lose 32% of their capital in the broad market, what money they have left is worth 24% less in buying power.
The combination of high inflation and investment losses creates a double loss.
A Tale of Two Investors
Imagine two Brazilian investors in 2011. One converts R$100 to dollars and invest in the US market. In 2011, at $1.50 per Real, that amount would buy about US$67 in U.S. shares.
The other player invests the money in the Brazilian stock market. The combination of the three variables - market performance, general inflation, and currency devaluation- create a magnified effect for these two investment decisions.
The investor in the US market would see their US$67 increase 48 percent to about $100. At the current rate 2.2 Reals per dollar, the investment is now worth R$220.
During the same period, the investor in the Brazilian market would feel a decline of 33% percent to R$66. The U.S. investor would have over three times the amount of the Brazilian investor.
Two Types of Inflation
Both the US and Brazil are suffering inflation, but two different types of inflation. The US has asset price inflation and Brazil has goods and service inflation. In the US, the money flow is pushing up, or inflating, the price of stocks. In Brazil, the money flow is pushing up and inflating the price of goods and services.
Because it is difficult to simultaneously bid up both the price of financial assets and the price of goods and services, when general inflation is high, stock market performance (asset inflation), will tend to be low. For example, in the late 60s, 70s and early 80s, the United States had high general inflation and poor stock market performance. This pattern also occurred between 1917 and 1920.
Currently, it is the same in Brazil, they have high general inflation combined with poor stock market performance. A pattern of high general inflation and poor market performance isn't foolproof, but is common and generates a headwind for investors.
Today Brazil is a difficult place to get a good return on savings. The three headwinds are poor market performance, currency devaluation and high general inflation.
Their current situation, of high inflation and poor stock market performance is likely to continue. The Bovespa will continue to struggle from the headwind of inflation, because the Brazilian central bank has an incentive to keep inflation high. High inflation helps to fuel the slowing Brazilian economy. The devaluation helps domestic exporters.
To protect their savings from inflation and currency devaluation Brazilian investors should consider moving part of their investments to the lower-inflation markets.
International diversification to more stable currencies will protect Brazilian investors from their three headwinds, a declining stock market (asset deflation), high general inflation (goods and service inflation), and rapid currency devaluation (asset deflation).
It is also important for Brazilians to keep a portion of savings in Brazil, as there is always a chance these headwinds could change. But diversification will help to smooth domestic market and economic actions.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational and educational purposes only. The views expressed in this article are the opinions of the author and should not be interpreted as individualized investment advice. Investment objectives, risk tolerances and the financial situation of individual investors may vary. Please consult your financial and tax advisers before investing.