Last weekend saw another set of massive demonstrations against Brazil’s hugely unpopular President, Dilma Rousseff. She has had the misfortune to preside over a severe economic downturn, but she can only partly blame global economic forces beyond her control. A great deal of the blame quite likely lies with her, her predecessors, and her party, and the climate of profound corruption in which they have spent their recent years in power.
As we have reflected on Brazil’s economic and political collapse, we have found ourselves comparing it to another country and other crisis: the U.S. recession and bear market of 1973 to 1974. The comparison is interesting because of what it suggests about identifying a bottom in the Brazilian market.
Is It the Economics, or the Politics?
Brazil’s collapse has correlated with converging overpowering macro processes: particularly the peaking of Chinese demand for the raw materials that drove Brazil’s recent expansion. Brazil finds itself at the center of a vicious commodity bust, exacerbated by the fact that the preceding boom was driven by the largest episode of migration and urbanization in the planet’s history — the movement of rural Chinese into China’s cities.
Likewise, the U.S. recession of 1973 to 1975 was driven by epochal forces: the peaking of domestic U.S. oil production, the coalescing of OPEC as an effective cartel and the skyrocketing of world oil prices (ultimately going from about $3 per barrel before the 1973 embargo to about $12 per barrel after the 1974 oil shock), the dramatic expansion of government spending on war and domestic social programs, an upwelling of revolutionary social disruptions, and the end of the post-war global currency regime. As many remember, the rising of world oil prices combined with the peak of U.S. oil production led to greater U.S. oil imports and helped exacerbate the recession.
In both cases, though, chaotic macro disruptions occurred at the same time as severe domestic political crises. When we look at the peak-to-trough market action in the United States, it seems to correlate closely with political events, in spite of the troubling macro backdrop.
The Watergate Scandal and the 1973/74 Bear Market
The chart below shows the S&P 500 index, marked with some of the key events of the Watergate crisis that engulfed and eventually brought down the Presidential administration of Richard Nixon:
Although the Watergate break-in and the initial arrests occurred in June, 1972, it wasn’t until October that Washington Post reporters Woodward and Bernstein published their front-page piece alleging that the conspiracy ran much deeper and involved “dirty tricks” against many of Nixon’s enemies and adversaries. Nevertheless, Nixon swept the November election in one of the most crushing victories ever won in U.S. presidential politics. The market peaked shortly after the beginning of the new year.
By May of 1973, the Senate had begun hearings on the scandal. In October, in the so-called “Saturday Night Massacre,” Nixon fired the special prosecutor who was investigating the scandal, and the Attorney General and Deputy Attorney General resigned. This turned the tide of public opinion in favor of impeaching the President, and began the most relentless phase of the market’s decline. Between the Saturday Night Massacre and Nixon’s resignation more than a year later, the S&P 500 dropped more than 25 percent. After the resignation, there was another severe down leg, but by the time Nixon’s successor, President Ford, pardoned him in September, the bottom was close. That bottom happened on October 3, 1974 — a decline of almost 50 percent from the peak in January, 1973. Altogether, from the Watergate break-in and the initial arrests, to Ford’s pardon of Nixon, the scandal lasted two years and three months, bracketing the bear market.
Brazil’s “Operation Car Wash”
Brazil’s corruption scandal has unfolded in a similar “slow-motion” way to the U.S. Watergate scandal forty years earlier:
Brazil’s Ibovespa Index During the Petrobras Scandal (Priced In U.S. Dollars)
The scandal began in March, 2014 with the arrest of a former Petrobras executive, Paulo Costa. In August, Costa signed a plea bargain and began to name other participants; the Brazilian market peaked shortly thereafter. It continued its decline as more figures were arrested and placed under investigation — eventually including many sitting lawmakers in the President’s ruling coalition. In July, 2015, prosecutors opened an investigation into Rousseff’s predecessor, the then-popular and charismatic Lula da Silva; in December, initial impeachment proceedings were commenced against Rousseff herself (although they remain stalled). On March 4 on this year, Lula was briefly detained and questioned. Last weekend’s rallies against Rousseff, demanding her impeachment, may finally get the process underway.
Watergate’s Lessons For Buyers of Brazil
Like the U.S. market in 1973 and 1974, Brazil’s current bear market will likely be bracketed by the ongoing Petrobras scandal, which has widened to the point that it is about to engulf both the current president and her once-popular predecessor (a man who was, for a while, thought to be a model of probity among developing-world leaders). As with Watergate, a slow build-up of the crisis went along with a continuing market rally — which then broke down with increasing sharpness as it was punctuated by more revelations of wrongdoing and increasingly fierce public displeasure (and as demand for Brazil’s commodities dropped, and iron ore and other Brazilian commodities fell in price as demand for their minerals and food also diminished abroad, especially in China).
The time-frame of the scandal is interesting: Watergate lasted 27 months, and the Petrobras scandal has now lasted 24. There may be another, final washout surrounding some cataclysmic political event — Lula’s conviction, Rousseff’s resignation, or some new, even more shocking revelation of corruption. (Lula has now been given a cabinet post in a bid to shield him from prosecution — a move by Rousseff which will surely be viewed as corrupt by many Brazilians.) We do not know whether the bottom is in. However, we think it is close, and that at this juncture, there is significantly more upside than downside risk in Brazil.
Investment implications: While the macro backdrop to bear markets is critical, the domestic political backdrop can have an even stronger influence on market psychology and the way in which the bear market plays out. We see parallels between Brazil’s current bear market, and the U.S. bear market of 1973 to 1974 — especially in the way developing domestic scandals shape the market’s fall. This comparison lends weight to the view that if Brazil’s market bottom hasn’t yet been put in, it’s close. We are buyers of Brazil on weakness.
