Brazil Stock Market Retrace Likely To Turn Around Say The Macro Fiscal Flows

by: Alan Longbon

Stock market correction in Brazil, despite strong macro fiscal flows, points to the possibility of a strong rebound after a hard run up since July 2017.

Positive fiscal flows add to the stock of funds in the private sector and negative flows take them away.

Overall the fiscal flows are strong at 8.3% and accelerating.

A positive macro picture for a land one is looking at investing in is a real prerequisite, and the purpose of this report is to assess if Brazil has a positive macro environment within which to invest.

Brazil is of particular interest now as the stock market has started to retrace the strong gains made since July 2017 and since my last report in September of this year.

One can summarize the national accounts in the following formulae:

Private Sector [P] = Government Sector [G] + External Sector [X]


GDP = Private Sector [P] + Government Sector [G] + External Sector [X]

These are accounting entities and are true by definition.

See the methodology section below for more detail on this formula.

Private Sector

The private sector is where the stock market is and we as investors want the stock market to go up. The stock market can only go up if the flows into it are positive. The private sector derives income from three sources:

  1. Credit creation from banks. - Banks lend more than is repaid in loans.

  2. Externally from overseas commerce.- Exports bring in more than imports cost.

  3. Government spending. - More is spent than taxed.

In an ideal scenario, the private sector would receive large, and growing income flows from all three sources, and at the very least, the overall impact should be a positive flow even if one or two of the three flows are negative.

The stock market in the private sector, as well as all other private financial assets, should rise if the overall income flow into the private sector is positive. Certainly, the stock market would be unlikely to rise if the income flows were negative. Even in a shrinking economy, some sectors can grow while the rest of the pie shrinks such as defensive sectors like consumer staples and utilities.

We will look at each inflow in turn and start with the private sector, all the while updating our forecast result based on the latest data.

The chart below shows the level of private credit creation entering the private sector through commercial banks.

The charts show that the credit collapse continues and has not yet bottomed and changed trend.

People are repaying their loans which is "unprinting" credit money created by the banks.

Private debt is very low in Brazil as the chart below shows.

(Source: Professor Steve Keen)

Private debt levels of 150% of GDP and above have been identified by Professor Steve Keen as the danger level.

Both households and businesses have been repaying their loans since a peak in 2016.

This shows caution in the private sector which is hardly surprising given the tumultuous political climate.

External Sector

The external sector captures trade and commerce with other countries and is best captured by the current account. The current account is exports minus imports, and it also captures capital flows in and out of the country from financial transactions and investments. A positive overall result is best.

This is the new data that we have, and it shows an improving picture.

The chart below shows the current account balance. Brazil has a poor current account balance with more funds flowing out than in. Like the credit creation picture, it is improving though. This year has seen a series of surplus months and 2017 is looking to be less of a drain than 2016 on overall fiscal flows.

The most recent data confirms a trend toward a better result that for 2016.

Government Sector

The government budget is shown in the chart below.

The government budget picture is a healthy one with big injections of funds into the private sector and is indeed the sector doing the heavy lifting and causing asset prices to rise.

The government plans to continue spending and is indeed having trouble not spending and this could go on until at least October 2018 when the next elections are held as this article documents.

This is a positive trend going forwards and looks to have at least a year left to run. If the socialists win there will be more and growing government spending and if the conservatives win there is likely to be economy shrinking austerity applied. It may well be that the market is now pricing in a conservative victory and the wealth crushing austerity policies that will come with it.

A government in political chaos but locked in spend mode could not be better for the private sector and is the opposite of what most other advanced countries in the world have at present.

Sectoral Analysis Methodology

Each nation state is composed of three essential components:

  1. The private sector

  2. The government sector

  3. The external sector

The private sector comprises the people, business and community, and most importantly, the stock market. For the stock market to move upwards, this sector needs to be growing. This sector by itself is an engine for growth and innovation; however, it needs income from one or both of the other two sectors to grow.

The government through its Treasury sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained. For a sovereign government with a freely floating exchange rate, any financial constraint such as a matching bond issue is a self-imposed restriction. A debt ceiling is also a self-imposed restriction as is a fiscal brake.

The external sector is trade with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.

For the stock market in the private sector to prosper and keep moving upwards, income is required to be put into the flow. Otherwise, the sector can only circulate existing funds, or is being drained of funds and is in decline.

The ideal situation is that the private sector has a net inflow of funds and is always growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.

The following formula can express this relationship:

Private Sector = Government Sector + External Sector


GDP = Private Sector + Government Sector + External Sector

These are accounting entities and true by definition.

For the best investing outcome, one looks for countries with stock markets located in private sectors that are receiving positive income flows overall. Top marks come where private credit creation, the government sector, and external sector are all in plus and trending upwards.

Conclusion, Summary and Recommendation

When we take our inputs and place them in our formula, we can calculate the following sectoral flow result based as a percentage of GDP.

Private Sector Credit Creation


Government Sector


External Sector





-1.4% 8.9% -1.3% 6.2%






(Source: Trading Economics and Author calculations based on same)

Brazilian sectoral flows are positive and strong at 8%. Looking forward, it appears that growth rates for the external sector and private credit creation, are improving. The large government sector flows look to be maintainable for years given the political gridlock has taken place at a time of high flow rates.

There is scope for financial assets such as stocks, bonds, and real estate to rise given that the private sector is receiving a positive inflow of funds.

Once again the stock market has fallen lately due largely to sentiment rather than hard economic facts. The macro fiscal numbers are still good. This represents another buying opportunity for the brave of heart. I trade these dips using the Direxion Daily Brazil Bull 3x Shares ETF and also contract for difference on the iShares MSCI Brazil Capped ETF.

An investor wishing to have exposure to the Brazilian stock exchange can do so through the following ETFs:

  • iShares MSCI Brazil Capped ETF (EWZ)
  • First Trust Brazil AlphaDEX Fund (NASDAQ:FBZ)
  • VanEck Vectors Brazil Small-Cap ETF (NYSEARCA:BRF)
  • Direxion Daily Brazil Bull 3x Shares ETF (BRZU)
  • iShares MSCI Brazil Small-Cap ETF (EWZS)
  • Ultra MSCI Brazil ETF (NYSEARCA:UBR)
  • Global X Brazil Consumer ETF (NYSEARCA:BRAQ)
  • Global X Brazil Mid Cap ETF (NYSEARCA:BRAZ)
  • Deutsche X-trackers MSCI Brazil Hedged Equity ETF (NYSEARCA:DBBR)

I recommended Brazil as a buy in June 2017 in this article. And it is still a buy due to the strong macro-fiscal flows.

During the dip caused by the Temer Tapes scandal, I did well using the 3 x ETF BRZU and exited the trade at my limit target. Since then I have been long using the less volatile ETF EWZ shown in the chart below until was finally stopped out in mid October. I now plan to take further positions in BRZU in the next weeks. The market may well find support on the 2017 February and May highs and that would be a logical enter point if the downward run slows and reverses.

I first recommended a position in Brazil in this article in December 2016, and since that time the above ETF has risen in value by 26% and paid a modest 1.78% dividend income. It was 50% up last month but has retraced since.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BRZU over 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.