Dear investors,
One of the sayings repeated over and over again by Charlie Munger, the Berkshire Hathaway partner who turned 99 this month, is that "To the man with a hammer, every problem looks like a nail." In its always laconic style, it is a criticism of the tendency to see the world in an overly simplified way, trying to explain everything through very restricted ideas, instead of trying to understand the nuances and complexities of each situation.
With all the turbulence that Brazil has been going through, the public of investors has been closely following every news, no matter how small, about economics and politics. We were no exception. We've devoted more time than usual to these topics in recent months. However, we have the impression that newspaper headlines have been given more weight than they should in the decisions of Brazilian investors. The news has been the “hammer” of the market, considered as a relevant factor in estimating the probable future of the economy even when it has a very speculative character or very limited impact.
Meanwhile, foreign investors bought around R$ 120 billion worth of shares on the Brazilian stock exchange in the last 12 months, sold by local investors. In other words, foreigners are “betting” that the future of our economy will be better than Brazilians themselves believe. Only one side can be correct.
Source: BTG (Brazil: Follow the Money)
There is an important detail: the sales of Brazilian institutional investors were not purely motivated by the opinions of their managers. Equity and multimarket funds suffered redemptions of R$ 146 billion in this period, which forces managers to sell so that they can return the money to their shareholders. Thus, this selling movement is a reflection of the allocation decision of the final public of Brazilian investors, which is especially susceptible to the “man with a hammer” syndrome, as they dedicate much less time than professional investors to delving into economic analysis.
To illustrate how some recent events may have had a greater impact than is justifiable, let's comment on two cases that gained attention in the last month: the breakdown of Lojas Americanas and the new government's announcement of its intention to create a common currency with Argentina, the SUR.
The American Breakthrough
From time to time a big case of fraud in the markets is revealed. In 2020 it was IRB Brasil. This month, that of the Americanas, which, it seems so far, no longer account for R$ 20 billion in debt on their balance sheets. The case has gained so much media attention that there are several articles explaining what happened and speculating about the possible future of the company, so let's assume some prior knowledge and just share our comments about it.
The value of the hidden debts is so great that the company has no chance of salvation without an injection of new capital, but, from a purely pragmatic point of view, the case is tragic for Americanas shareholders, who saw their investments in the company reduced to dust overnight; bad for the company's creditors and suppliers, who will not receive everything they are owed; indifferent to most of the market, which had nothing to do with the American ones; and good for competing retailers, who will be able to grab a good part of the market share hitherto occupied by the American ones.
The largest group among these four are the indifferent or unaffected. The gap was gigantic for the company, which was worth R$ 10 billion on the stock exchange, but not so relevant for the stock exchange itself, whose set of companies listed today is worth around R$ 4.2 trillion. However, the theme gained such prominence in the markets that it even increased the general cost of private credit operations. Banks and credit fund managers have suddenly become more aware of this type of risk (which has always existed) and have begun to overestimate its relevance when calculating the appropriate interest rates for each loan. There is a completely different episode that well illustrates this exaggerated reaction to a newly materialized risk.
On September 11, 2001, two planes were hijacked by terrorists and launched against the World Trade Center buildings (the twin towers) in the United States. After that, the number of air passengers in the United States suddenly dropped by more than 30% from the number of passengers in the previous months. With the memory of the terrorist attack fresh in their minds, the fear of flying increased and countless people decided to replace plane trips with car trips, a decision quite understandable and intuitive to human psychology, but completely irrational. The risk of death from air travel is much lower than the risk of death from road travel (currently about 18 times lower for commercial airliners). So the decision to travel by car, spurred on by the recent memory of the attack, killed thousands and thousands of people around the world. A much quieter tragedy than that of the people in the buildings attacked, but just as lethal.
In our last letter, we talked about the difficulties of maintaining rationality even when it points in a different direction than is intuitive. It would certainly be uncomfortable to take a flight seeing photos of the collision of the planes involved in the terrorist attack all over the front pages of newspapers, but it would still be the rational decision. One of the most important skills for an investor to cultivate is to act in ways that make sense, rather than in the most psychologically comfortable way.
One last comment about Americanas before moving on: to avoid investing in the company, it was not necessary to detect fraud, something very difficult to do looking at the company from the outside, it was enough to note that it had 9 years of losses in the last 10 years and depended on several successive capital injections to remain solvent. These are not traits of good business.
The daydream about SUR
On his first diplomatic trip to Argentina, the new president announced the possible creation of a common currency to facilitate commercial transactions in Latin America, with the suggested name of SUR. The episode caused some initial uproar, but reverberated much less in the market than the case of Americanas, we imagine that, by consensus of several specialists, the plan should not get off the ground. In our own analysis of how a project of this nature could evolve, we sought to understand what stage Mercosur was in when compared to the history of the European Union.
In 1957, the European Economic Community (EEC) emerged, the economic bloc that preceded the European Union and was born establishing free trade and labor transfer in the signatory countries. After 13 years (1970), a group was created in charge of drawing up a plan to unify the currency of the member countries, whose implementation was initially frustrated by the complexity of aligning several currencies in the midst of exchange rate instabilities. Only 9 years later (1979) did the European Currency Unit (ECU) appear, a scriptural currency used for financial transactions between the countries of the economic bloc. The ECU evolved into the Euro 20 years later (1999), and the adoption of the Euro as a circulation currency still took another 3 years (2002).
If we equate the recent announcement about the intention to evaluate the creation of SUR with the creation of the European study group that emerged in 1970 and follow the same timeline from that point onwards, Sur would be born in 2032 as something similar to what was the ECU and would become a common circulating currency by 2055. Even if there is political will now, there are so many complexities and pitfalls that something like this is hardly possible to implement in just one presidential term, so it would need the support of consecutive governments in both countries so that one day it gets off the ground. It may never happen.
This brief history is enough to dispel concerns about possible impacts that this project could have in the short term. Also considering the barrage of criticism that the idea received, it is possible that the new government does not even want to spend political capital taking this issue forward.
The world likes news
The risk of following these economic and political events too avidly is to gradually lose sight of the whole. In the eagerness to consider each novelty, start to forget the structural factors that develop slowly but have the greatest impact.
In the letter we published in November, we talked about the positive impact that the trend towards decentralization of production chains, which today are very dependent on Asian countries, could bring to Brazil's economic development. In the same direction, the plan to decarbonize the economy can make the Brazilian energy matrix, much cleaner than the average, an attraction for new investments in our country. These factors will remain valid over several years, but tend to be forgotten by the general public and give space to news, however less relevant they may be compared to old news.
Although news impacts stock prices in the short term, price movements in the long term are much more correlated with the financial results generated by each company. Thus, a constant effort is needed to maintain coolness and skepticism in the face of current issues, separating what really can make a lasting impact from what is just noise. Especially in relation to political agendas, where the noise rate is high.
What do buyers see?
Looking at the Brazilian scenario from afar, with a wider range of vision and less attention to each political storm, our dramas are part of the country's normality: Brazil is always going through controversies and scandals. The specifics of the current drama are of little relevance in the long term perspectives. It is most likely that Brazil will continue with the low economic growth that it has been showing in recent decades, the result of confusing legislation, enormous productivity challenges and an inefficient State.
Despite not being a very encouraging prognosis, this baseline scenario is already reflected in the average price levels in the local market. This is why real interest rates are higher and company valuation multiples in Brazil are lower than in developed economies. What motivates investors who are buying now, whether foreign or not, is certainly the current price level, well below the averages that already take into account our always lukewarm economy. It is a discount level that offsets a good deal of macroeconomic and political risks.
We have already said that prices have been low for several months and the fact that we have not yet seen a reversal of trends in the market can bother the most daring, so it is always worth emphasizing that the moment of reversal is unpredictable and may take several months. We invest always thinking about the long term, not because we like to make money slowly, but because we believe this is the safest and most assertive approach possible.
On the 08/02th we will do a live via Zoom commenting on this month's letter. sign up
clicking here.
