The Economic Case for Brazil

Welcome to the first edition of the Global Leaders Ledger. Throughout this newsletter we will explore today's most pressing macroeconomic trends, investment ideologies, and global market developments. While we will focus on a quantitative approach to our research for our metric-driven leaders, we will also analyze the qualitative aspects of the data presented. Thank you for joining us, and we look forward to exploring the globe with you.

A large part of our 50-year macro outlook is rooted in the vast potential for exemplary economic performance out of BRICS and BRICS+ nations. Today we will begin to dissect the who, what, when, where, and why contributing to this thesis. Let's begin with a high-level examination of Brazil.

Economic Diversity

Brazil boasts a highly diversified economy, with strong contributions from agriculture, mining, manufacturing, and services. This diversification provides a solid foundation for growth, as it mitigates the impact of sector-specific downturns and global economic fluctuations. As global demand for commodities continues to rise, Brazil's vast natural resources and agricultural output will drive economic expansion and boost investor confidence in its equity markets.

Manufacturing

With the second largest manufacturing industry in the Americas, Brazil is uniquely positioned to sustain short and long term economic and population growth. Strength in the industry directly correlates (and yes, contributes) to sustainable economic growth in several forms ie employment, innovation, infrastructure development, etc… Manufacturing contributes a strong ~20.7% of Real GDP, and is growing with an impressive 4.48% CAGR, putting Brazil in the 99th percentile for manufacturing growth, not including additional qualitative data like the economic multiplier effect (the industry’s ability to impact other industries).

Services

Services in Brazil currently make up roughly 73.1% of GDP, up from 72.7% in 2017- demonstrating growth in a crucial piece of sustainability for a high-performance period. With Brazil’s services sector continuing to develop, the sector is able to provide crucial support for other critical industries like manufacturing, mining, and agriculture- further driving economic growth and equities performance.

Agriculture

To outperform U.S. equities throughout the decade, Brazil must have the ability to produce agricultural goods and commodities for their country, as well as export; both conditions currently being satisfied by the country. 6.6% of GDP is derived from the sector and is showing strong growth with imports dropping 11.6% while exports are up 12.6%

Demographic Advantage

In addition to Brazil’s strong economic diversification, the country also has a significant demographic advantage. When we think of periods of economic prosperity and increased performance, the demographic factors contributing to this success are rarely discussed. We find a lot intriguing in Brazil’s case.

Large and Young Population

With over 210 million people living in the country (5th most populous on the globe), you might think the median age would more closely resemble other Latin American countries- this is not the case. The average age of a Brazilian resident is only 33. This young, working-age population can and will provide a strong labor force over the next 29-32 years (retirement age is 65 for men, 62 for women). This leads us to our next point.

Demographic Dividend

Brazil is currently experiencing a demographic dividend, a period when the proportion of the working-age population is significantly larger than the dependent population (children and elderly). This condition presents an opportunity for Brazil to invest in human capital, enhance productivity, and boost economic growth, during a period of minimum liability.

Urbanization

Approximately 86% of Brazil’s population is currently living in urban areas. Urbanization can lead to increased productivity, as it concentrates human resources, infrastructure, and economic activity, fostering innovation and economic growth. For context we look at the successes urbanization brought forth out of the United States, China, India, Japan, Germany, etc…

Education and Skills Development

Brazil has made significant strides in improving access to education, resulting in a better-educated workforce. Continued investments in education and skills development can further enhance the country's human capital, contributing to its demographic advantage. In 2020, the country boasted a 54.6% gross enrollment ratio for tertiary school- no new data has been released since then, however, given other macroeconomic and social indicators, we expect this number has risen since then.

Female Labor Force Participation

The female labor force participation rate in Brazil has been gradually increasing, from 50.62% in 1990 to 71.97% in 2021, reflecting a more inclusive, holistic labor market. Increased female participation is contributing to the size and diversity of the workforce, driving economic growth and improving societal outcomes.

Infrastructure Development

The Brazilian government has made infrastructure development a priority, investing heavily in transportation, energy, and telecommunications. These investments will not only improve the overall efficiency and competitiveness of the Brazilian economy but also create new opportunities for public and private equities in the infrastructure sector. As these projects mature, they will generate significant returns for investors and further establish the foundations on which growth (economic and social) thrives.

Let's take a peak at the most notable developments ongoing in the sector as they relate to foundational economic growth:

The Brazilian Government has embarked on an extensive privatization initiative, utilizing a series of concession auctions and regulatory reforms designed to draw financing and close the widest infrastructure funding gap in Latin America. The Ministry of Infrastructure (MInfra) has conducted virtual roadshows for international audiences, presenting concession opportunities across railways, airports, highways, and ports. Both the Ministry of Regional Development (MDR) and the Investment Partnerships Program (PPI) have been actively promoting these projects on a global scale to attract investment in infrastructure projects. In August 2022, Brazil's then-Minister of Economy, Paulo Guedes, stated that the government had amassed over $24 billion in concession fees and received commitments for investments exceeding $96 billion.

In December 2021, the Brazilian Government introduced new rail legislation permitting the use of an authorization model that allows private entities to Design-Build-Operate (DBO) under the Pro-Trilhos program. As of October 2022, 89 new requests for constructing and operating short lines had been submitted, representing over 22,000 km of new railways across the country and an estimated private investment of $49.6 billion. The government anticipates that the DBO authorization model will result in a 40% expansion of Brazil's rail cargo transportation matrix over the next 30 years.

Note: Brazil conducted presidential elections in November 2022, with the new administration assuming office on January 1st, 2023. The Ministry of Infrastructure was subsequently split into two new ministries: the Ministry of Transport and the Ministry of Ports and Airports. New statistics and projects are expected to emerge in the coming months.

Economic Reform and Fiscal Responsibility

The World Bank Group has collaborated with Brazil's government to tackle capacity, institutional, and regulatory obstacles that impede the nation's sustainable rebound and accelerated inclusive growth at both federal and subnational levels. Alongside addressing the immediate consequences of Covid-19, pursuing a green, inclusive, and sustainable recovery from the pandemic necessitates reforms promoting fiscal sustainability, poverty alleviation, and productivity.

The Country Partnership Framework (CPF) for Brazil for 2018-2023 is based on three key components:

1. Fiscal sustainability and enhanced service provision. This component emphasizes fiscal adjustment support at federal and subnational levels, including pension and social protection systems. It also seeks to improve the efficiency of public service delivery, particularly in education and healthcare.
2. Increased productivity and private sector investments. The goals under this component include efforts to eliminate regulatory barriers that hinder competitiveness and address distortions in the credit market while encouraging infrastructure investments.
3. Inclusive and sustainable development. This goal aims to support Brazil's ambitious Nationally Defined Contribution (NDC) under the Paris Agreement by fostering global partnerships.

In May 2022, the Performance and Learning Review (PLR) for Brazil factored in the changing government priorities and the unparalleled impact of the COVID-19 pandemic on the nation. As a result, the PLR suggested concentrating the rest of the CPF implementation on managing the pandemic's effects and promoting a greener, more inclusive, and fiscally sustainable recovery. This will be achieved through a blend of World Bank Group financing, analytics, and institutional reinforcement initiatives. The preparation of a new CPF (FY24 onwards) is slated to commence early in 2023.

Attractive Valuations

Amid the haze of domestic political and fiscal uncertainty, investors may still discover Brazilian equities well-positioned to capitalize on structural growth trends within their industries. While historically low valuations of Brazilian equities generally offer the potential for increased gains, selection remains crucial.

Brazilian equities are trading at diminished valuations due to the lingering concerns of domestic political and fiscal uncertainty brought on by the new government. The external environment for emerging market equities and global growth expectations have put pressure on Brazil's equities. MSCI Brazil is trading at its lowest P/E multiple since 2010, and the country's equities are among the lowest P/E multiples across emerging markets.

We believe the situation is improving for Brazilian equities, with high-quality companies poised to benefit the most. The global scenario has been favorable for emerging market equities year-to-date, marked by slower GDP deceleration, more resilient commodity prices, and ongoing disinflation. China's reopening and the increased demand for Brazil's commodity exports are generally positive for Brazil's currency (BRL) and equities.

Brazil seems to be ahead in its disinflation process compared to developed economies. The central bank could maintain the Selic rate at 13.75% for most of 2023 and begin easing by the end of this year. Finance Minister Haddad's economic measures to halve the primary fiscal deficit for 2023 from the anticipated 46 billion or 2.1% of GDP to $20 billion or 1% of GDP seem to be a net positive for the stock market. These factors appear to create a positive tailwind for Brazilian equities, and potential BRL appreciation could contribute to the real rates of return for international investors

Conclusively

Analyzing Brazil's position for growth i.e. the diversified economy, demographic advantage, infrastructure development, economic reforms, and attractive valuations, we see a robust case in support of the likelihood that Brazilian equities will significantly outperforming U.S. equities from 2023 to 2031. As the Brazilian economy continues to expand and mature, investors who recognize the country's potential and position themselves to assist in this inevitable growth stand to reap the rewards of this emerging market giant's growth.