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Brazil Banks Lead Brazil Stocks And Latin America Small Caps Lower, As Investors De-Lever From The Risk Of Central Bank Intervention, And Excessive Use Of Credit By Brazil’s Consumers

|Includes: BBD, BRAF, BRF, WisdomTree Brazilian Real ETF (BZF), EDV, EMB, EWZ, ITUB, UBR
Investment report on Brazil for the week ending February 4, 2011

1) … Brazil has often been held forth as a marvel of carry trade and neoliberal Milton Friedman economic expansion; it is now imploding and leading the emerging markets into the Age of Deleveraging.

The neoliberal Milton Friedman, Free To Choose, floating currency regime has provided the framework for one to profit, from money being carried up and down vigorously, by waves of central bank momentary policy, as well as by Yen based and Swiss Frank carry trade lending. Brazil was a darling of the global carry trade, attracting US, European and Japanese funds chasing yield. The Brazilian Real, BZF, had been the Latin Swiss Franc. Now vigilant investors are jumping from the Brazilian Titanic.

Ambrose Evans Pritchard provides this insight on Brazil:  “Finance minister Guido Mantega has called it a "currency war that is turning into a trade war", claiming that Brazil is the victim of manipulation by both China and the US - the latter through quantitative easing. Brazil’s trade deficit doubled last year to $71bn, and there is evidence that the strong real is letting Asian exporters eat into Brazil’s industrial base. The government has already adopted 28 anti-dumping measures against China, covering steel, tyres, synthetic fibres, chemicals, shoes and toys. China’s annual exports to Brazil have jumped from $5bn to $26bn in five years.”

1A) …  When one looks at the chart of Emerging Market Bonds, EMB, and looks at the 30 10 US Sovereign Debt Leverage Curve, $TYX:$TNX, one can see that the Emerging Market Bonds were destabilized much like the Gold Mining Stocks, GDX, and the 30 Year US Government Bonds, EDV, were destabilized, as investors derisked from US sovereign debt.

Of note, the gold mining stocks rallied this last week, how much longer they will rally with gold, when other stocks turn down is any one’s guess.

Investors began derisking and deleveraging out of Brazil investments beginning in November and December 2010, that is out of the Brazil Financials, BRAF, Ita, ITUB, Banco Bradesco, BBD, Brazil Small Caps, BRF, and Brazil, EWZ, … as is seen in the ongoing Yahoo Finance chart of BRAF, ITUB, BBD, BRF, EWZ, and EMB … as Carla Mozee, MarketWatch reported in December 3, 2010 article Brazil Raises Reserve Requirements:  “Brazilian banking stocks fell Friday, underperforming the broader market, after the country’s central bank implemented credit-tightening measures as part of a larger bid to cool inflation. The rough ride earlier in the session stemmed from the central bank’s announcement that it will raise reserve requirements on term deposits to 20% from 15%, as well as raise additional requirements on demand deposits to 12% from 8%.

It’s also increasing capital requirements on consumer loans with maturity of more than 24 months to 16.5% of the loan from 11%, with the move aimed at reducing credit expansion to consumers, said Deutsche Bank analyst Mario Pierry in a note to clients.

He said it indicates the central bank is concerned “that consumer leverage has been rising at a fast pace and that debt servicing levels in Brazil are well above other emerging markets, at around 25%” of total income.

The central bank has also been concerned with rising inflationary pressures that have pushed the key inflation reading past its 4.5% target. In recent months, the central bank has moved to curb a rise in the value of the currency as investors have been attracted by high-yielding assets found in Brazil.

Shares slumped 3.3%, their steepest decline since early November.

Large banks may be hurt by the new measures as they will likely face short-term pressure on cost of funding and the need to reduce terms and require larger down payments, Bradesco BBI analyst Carlos Firetti wrote Friday.

The central bank estimated the measures will reduce liquidity in the financial system of Latin America’s largest economy by 61 billion Reals ($27.1 billion).

In the foreign-exchange market, Brazil’s currency, BZF, rose against the dollar, trading at 1.685 Reals compared with 1.703 Reals on Thursday.

Pierry at Deutsche Bank said the new measures could impact the broker’s 2011 earnings estimates for Brazilian banks by 10% to 15%. He also noted that economist Jose Faria believes the measures will “reduce pressure on the [central bank] to raise rates next week,” but that policy makers are likely to start hiking rates in January.

Central Bank Governor Henrique Meirelles, who will give up his post when the Rousseff administration enters in January, reportedly said Friday the measures will help stave off the risks of the formation of a credit bubble. The likelihood of an increase in the key Selic rate next week has “dropped significantly,” Citigroup analyst Marcelo Kfoury wrote to clients. “Therefore, we maintain our call that the central bank should resume the tightening cycle only in its January meeting,” by a hike of 50 basis points. The Selic rate currently stands at 10.75%. Kfoury also maintained the call for total tightening by about 200 basis points, which would leave the key Selic rate at 12.75% by the end of 2011.

1B) … Latin America Small Caps, LATM, traded lower. It is the small cap stocks that are affected first and the most by delveraging out of bank stocks and unwinding of carry trade investments.

1C) … Competitive currency deflation is coming at the hands of the FX currency traders.
They have been successful in short selling four currencies: The first was the Emerging Market Currencies, CEW, on inflation destruction seen in Indonesia, IDX, and Turkey, TUR, and also on China bank and credit tightening. The second currency was the South Africa Rand, SZR, on a falling price of gold, GLD, and on Africa, AFK, turmoil. The third currency to be sold this year was the US Dollar, $USD, in advance of Ben Bernanke’s press statement of ongoing purchase of debt. And the fourth is now the Euro, FXE, on bickering over European economic governance. The evidence is clear, cogent, and convincing that the bond vigilantes have teamed up with the FX currency traders to carry out a global currency war of competitive currency devaluation on the World Central Bankers, State Finance Ministers, and Treasury Secretaries, for domination of the worlds peoples and resources.

1D) … We are witnessing inflation destruction, which is the fall in investment value that accompanies derisking and deleveraging out of investments that were formerly inflated by money flows to, and carry trade investing in, high interest paying financial institutions, profitable natural resource companies, and high growth companies. Inflation destruction commenced in Brazil Financials, BRAF, and in the high growth Chinese Small Caps, HAO, in November 2010, and in Coal Producers ANR Resources, ANR, and Arch Coal, ACI in January 2011. Inflation destruction begets more of the same as former vigilant investors turn short sellers, and carry out their attack on their former investment, by going short the 200% ETFs, such as ProShares Ultra Brazil, UBR

Inflation Destruction may precede Debt Deflation which is the contraction and crisis that follows credit expansion. One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

1E) … The world is passing from The Age of Leverage characterised by debt expansion, credit liquidity, stability, economic growth and expansion and prosperity  …  and passing into The Age of Deleveraging characterised by debt deflation, credit ill-liquidity, instability, economic contraction and austerity.

In such an investment adverse environment, wealth is best preserved by investing in gold and silver bullion.

2) … It’s hasta la vista baby to sovereign debt, and hello to the rise of global economic governance arranged by Leaders’s Framework Agreements.  
The World Central Bank Leaders, and Government Finance Ministers have lost their monetary seigniorage, that is their debt sovereignty to the bond vigilantes as established by the fall lower in US 30 Year Government Bonds, EDV, US 10 Year Notes, TLT, World Government Bonds, BWX, and International Corporate Bonds, PICB.  

I believe that there will come a day when, out of soon coming financial chaos, that a World Chancellor, the Sovereign, and a World Banker, the Seignior, will rise to power and provide credit and moneyness, but at a cost, that being the loss of national sovereignty. The word, will, and way of the Sovereign and the Seignior will be sovereign globally. Austerity will be required of all. Eventually, there will be a one world currency, that is a global currency, and unified regulation of banking globally as as referred to in the James Politi and Gillian Tett Financial Times article NY Fed Chief In Push For Global Bank Framework,

Could it be that world central bank leaders are now preparing to go beyond traditional capital controls, and are preparing for a world wide federal reserve system, that is a global banking system?  Might it be that Leaders’ Framework Agreements, whether formally announced, or agreed upon in private, will serve as the basis for a unified one world banking system to deal with global instabilities?  Perhaps so, as Robert Wenzel of EconomicPolicy relates in article Geithner Jets To Brazil:  “On Sunday morning, Treasury Secretary Geithner will depart for Sao Paulo, Brazil where he will meet Monday with senior government officials, local business leaders and economists to consult, according to the Treasury on "shared bilateral and G-20 objections and highlight the importance of economic and financial cooperation with the Government of Brazil.””

3) .,. Brazil had seen explosive economic growth that came from the use of credit, investment in Bank stocks, carry trade lending as well as inflation.

3A) … Karvy Global in The Street reports on December 6, 2010 Two Brazilian Bank Stocks To Watch

Brazilian banks are among the most profitable banks in the world, with an average return on equity of 15%-25%. The country's banking sector and economy are benefiting from the burgeoning middle class. Statistics show that Brazil's middle class is expanding, with 50% of the population (200 million) categorized as middle class. Credit card purchases in the country have been rising at 22% per year, since a decade now.

Banks are the second-best performing sector in Brazil, EWZ, with the MSCI indicator of financial stocks increasing 34%, as of date from June 30, against the 35% rise in the industrial index, and 14% for the benchmark Bovespa.

We have listed two Brazilian banks -- Itau Unibanco Holding, ITUB, and Banco Bradesco, BBD,  with potential upsides in the future, supported by the country's strong banking sector.

JPMorgan Chase and Credit Suisse foresee Brazilian banking stocks benefiting from interest rate hikes. As per the median estimate of a central bank survey of 100 economists, it is likely that policymakers will raise the benchmark interest rate to 12.25% in 2011 from the current 10.75%, in order to combat spiraling inflation, which is currently hitting 28-month highs.

Credit Suisse has raised banks' ratings to overweight, as higher lending rates will boost earnings.

Marcelo Gil de Souza, global head of Accenture’s Corporate Strategy, says the rate of home mortgage loans is growing rapidly, although from a small base. Home mortgages are expected to experience the best movement in Brazil over the next few years. Currently, real estate credit accounts for only 3% of GDP, while total credit to GDP is at 45%. Accenture believes that the growth in the mortgage market will narrow the existing gap. By year-end, overall bank credit is estimated to reach 48% of GDP, a 22% jump from 2009 levels.

During October, outstanding loans were up 1.9% month on month and 20.3% year over year, as per Brazil's central bank data. Lending to the private sector rose 2% on a monthly basis, while housing loans to individuals and housing cooperatives grew 3%. The average interest rate on consumer credit stood at 40.4% in October, compared to 39.4% in September, increasing for the first time in three months.

Credit operations of financial institutions are on a positive trend, coupled with favorable developments in income and employment levels, as per the central bank. This has led to demand growth in investment and working capital of not only enterprises, but also household consumption of durable goods, the bank added.

Itau Unibanco Holding, Brazil's largest private-sector bank, engages in commercial and investment banking, consumer credit to non-account holders, corporate, and treasury activities.

The bank recently said that the merger between Banco Itau Holding Financeira and Uniao de Bancos Brasileiros will improve operational efficiency during 2011, further boosting the share price. Itau Unibanco was formed when Itau acquired Unibanco in 2008, with total assets of $261.4 billion. In comparison to rival banks, Itau did not generate attractive returns for investors, due to increased spending for the integration of branches and technology between the two banks. However, Itau believes that 2011 will throw up a pleasant surprise for investors.

For the third quarter ending September 30, net profit was up 19%, compared to the year-ago period. Loan portfolio expanded 16.6% year over year. The bank offers an attractive 23.84% return on equity with a past record of 30% sales growth and earnings rising around 20% annually during the past three years. The bank has a strong pipeline of potential acquisitions and regards Mexico, EWW, Peru EPU, and Colombia as the hunting ground for acquisitions. Moreover, Itau is keen on broadening its current business in Chile, ECH.

During November 2010, the bank sold $289.4 million in five-year real-denominated global bonds with a yield of 10.5%. Fitch Ratings has assigned a BBB rating to the bonds and believes that the proceeds will be used for general corporate purposes.

Banco Bradesco, Brazil's second-biggest bank by market value, is a private-sector commercial bank offering a suite of banking and financial products and services within and outside of Brazil. The bank is the first national sponsor of the Rio 2016 Olympic Games, exclusively in the finance and insurance services categories. This sponsorship will benefit Bradesco in the longer term, as private and public-sector spending is seen accelerating in Brazil beginning in 2011.

For the three months ended September 30, adjusted profit jumped 40%, compared to a year ago, while the loan portfolio expanded 19%. For 2011, the bank expects its credit portfolio to increase in the range of 15%-20%. The bank's return on equity for the third quarter stands at an impressive 21.69%. Revenue from outside Brazil accounted for almost 37% during third-quarter 2010.

Fidelity National Information Services, FIS, an electronic payment processor, has signed a deal with Banco Bradesco, also a Brazilian card processing bank. Under the contract, Fidelity will provide card processing, call center, collection, and back-office services for Bradesco's private label and bank cards, including its Visa and MasterCard portfolios..

Bradesco is planning to raise $872 million through a rights offering to shareholders, Dow Jones reports. The bank plans to roll out 62.34 million new shares priced at BRL 24.06 per share, with half the amount issued as preferred shares and the remaining as common. The plan of operations for the offering will be discussed at a shareholder meeting scheduled for December 17.

Meanwhile, the bank plans to open brokerage offices in Hong Kong and Tokyo during March-April 2011, with new service offerings, including private banking and asset management services. In London and New York, Bradesco is moving offices and is looking to hire more people in the U.S. Total income for the third quarter included a 29% contribution from fee-based income.

The growing demand for emerging market equities and debt instruments has been increasing the bank's corporate debt sales, with new issues in Brazil amounting to $88 billion so far in 2010. Of the 10 analysts covering the stock, six recommend buying, with a 13% upside from current levels. Bradesco has four hold ratings. In the past five days, the stock has accumulated 1.3% as compared to 0.2% by the Bovespa Index.”

3B) … Investopia reports on November 9, 2010: The demand for commodities such as iron ore, steel and sugar has helped the Brazilian economy recover from the recession.

This BRIC nation, EEB, has become one of the favorite geographic regions for investors, but with much of the attention going to the resource companies, (commodity companies), it could be time to shift attention to the financial sector.

Brazil's #1 and #2 private banks, Banco Bradesco, BBD, and Banco ITau, ITUB, have benefited from the country's economic recovery by meeting demands for mortgages, consumer loans, insurance and investments. Over the past five years, Banco Bradesco's stock price is up 162%, while Banco Itau is up 88%. Since the beginning of the year Banco Itau is up nearly 12%, slightly outpacing Banco Bradesco's 9.3% return. Besides the stellar stock returns, other similarities and differences between the two are worthy of investors' attention.

Banco Bradesco is one of the largest banks in Brazil. Banco Bradesco's main business areas include its banking unit and its insurance, private pensions and savings bonds unit. Lower to middle income Brazilians. Banco Bradesco also has operations beyond Brazil's borders in Argentina, the U.S., Cayman Islands, and the United Kingdom, (all popular carry trade lending centers)