November 4, 2012 6:53 pm

Why I remain a pessimist on Europe’s solvency

I should have known what would happen when you pose a question at the end of a column. Last week I asked how it could be, that somebody who was pessimistic about the eurozone six months ago could be optimistic today? If you always thought it was just a liquidity crisis, you should not have been worried then, and you would be right to be optimistic now. If you thought of it as a solvency crisis, as I did, you should still be worried now.

Several readers pointed out to me, quite rightly, that I offered only an extreme choice. What about a solvency crisis that is not inherent but caused by a liquidity squeeze – a self-perpetuating insolvency crisis? Solvency is, after all, an analytic concept. It depends on the level of debt, future growth, ability to tap private sector wealth through taxation, ability to raise funds through privatisation and, of course, future market interest rates. Reasonable people could disagree on all of these. Even Germany could be considered insolvent if you assumed a sufficiently high interest rate.

Distinguishing pure sovereign risk (minus the contingent liabilities for the financial and non-financial private sectors) from risks that have arisen purely in those sectors, my judgment on the solvency of various entities in the eurozone has been the following. In the first category, I consider Greece to be unconditionally insolvent; Italy and Portugal to be solvent – but conditional upon a return to sustained growth. I consider the sovereigns of Spain, Ireland and the rest to be fundamentally solvent minus the banks, of course. In the second category, I consider the private and financial sectors in Spain, Portugal and Ireland to be insolvent.

Once you conflate sovereign and financial sector risk, the situation becomes more complicated. My bottom line is that the national backstops have not removed, and have possibly increased, the total solvency risk in the system.

Even worse, I believe the outlook for solvency has deteriorated over the past six months due to the effects of austerity on growth at a time when interest rates have hit their lower limit. The economists Dawn Holland and Jonathan Portes have pointed out one other reason why the fiscal multiplier is unusually high at the moment: everyone is pursuing austerity at the same time. We may well have crossed the line where austerity not only raised debt ratios in the short run, which is to be expected, but may end up increasing them even in the long run – so that it becomes self-defeating.

So if you started from where I did, you cannot be optimistic. But then again, as an Irish saying goes, you might not start from here.

John McHale, economics professor at the National University of Ireland, Galway, has argued that official policy can restore financial health in a self-perpetuating solvency crisis, provided a number of conditions are met. He lists four. First, the liquidity support given through the European Central Bank’s Outright Monetary Transactions programme and other mechanisms must be reliable. Second, the conditions must be reasonable.

Third, the conditionality must be flexible unanticipated shocks should not trigger fiscal adjustments in future. Fourth, the link between banking sector losses and state debt must be broken.

I concede that these conditions, especially the fourth, could restore solvency everywhere except in Greece. The problem is that they stand in contrast to official policy. The ECB has only announced the OMT programme. So far, nobody has made an application. The Spanish prime minister is still playing hard to get and I doubt he will make an application this year. The OMT may end up as a phantom. As in Hans Christian Andersen’s fairy tale – I am writing this column from Denmarkit may not be very long until some child in the bond markets points out that Mario Draghi has no clothes.

Second, it has been, and continues to be, official policy that countries must heap one austerity programme on top of another if they miss nominal deficit targets – which they do because they keep underestimating the fiscal multiplier. Finally, even though I assume that eurozone leaders want to set up a meaningful banking union, I see no chance that this will lead to a separation of banking and sovereign risks. Angela Merkel stated clearly that this was not going to happen.

The main significance of the OMT, should it ever become a reality, would be to prevent a contagious spiral between bank debt and sovereign debt for approximately two to three years. This would be important in its own right, but does not in itself improve the underlying solvency of the various entities, given current policy choices.

You have to make some brave assumptions about the futurecontinued rollover, separation of banking and sovereign risks, readiness for fiscal transfers, readiness to abandon austerityall of which stand in complete contrast to officially announced policies. Solvency thus depends on the assumption that official policy is a lie. One could make that assumption, of course. I have not, and would not.

Copyright The Financial Times Limited 2012.

martes, noviembre 06, 2012




Betting on Brazil


The world's sixth-largest economy has hit a rough patch, but the future looks bright, given a rising middle class. Where to invest in 2013.

Leonardo Martins/Getty Images
The view across Rio de Janeiro's beautiful Botafogo Bay.Añadir leyenda

The carnival is over in Brazil, at least for the next six months. After surging 7.5% in 2010, the world's sixth-largest economy is expected to grow just 1.5% this year and 4% in 2013, amid slowing global demand for natural resources and a sluggish industrial sector.

Reflecting these challenges, the country's stock market has been one of the worst performers in 2012, with a year-to-date gain of 2.9%, and Brazil's currency, the real, dropping sharply in value against the U.S. dollar. If the government, led by center-left President Dilma Rousseff, can't spur industrial production sufficiently in the months ahead, gross domestic product could fall short of next year's estimates, while consumer-price inflation, already at a steep 5%-plus, could accelerate, driven by rising food prices.

But don't give up on the land of sun and samba, because Brazil's longer-term prospects could make it one of the world's best investments in years to come. The Brazilian middle class continues to grow, as does its disposable income, which is spurring demand for products from cars to eyeliner to beer. The jobless rate is a low 5%, and consumer trends could become even more powerful in the next decade, regardless of developments in other parts of the world, including China.

Although the economy mostly has stumbled since Rousseff took charge in January 2011, the president has continued many of the market-friendly policies of her predecessor, Luiz Inácio Lula da Silva. Brazil has lowered interest rates and cut taxes, and is planning to ramp up spending on infrastructure, which could pay big dividends down the road. Much of the spending involves preparations to host the 2016 Summer Olympics, an event that could showcase Brazil's progress and burnish its image in the eyes of the world.

The Bovespa, Brazil's benchmark stock index, trades for an inexpensive 11.7 times this year's expected earnings. While its price/earnings ratio is richer than those of fellow BRIC members Russia and China (India rounds out that quartet), Brazil's financial system arguably is more transparent than the other three, and its shares, more liquid.

When the Brazilian economy was roaring, with growth of 6% to 7% a year, investors could throw darts at the Bovespa and effectively strike gold. Now, those seeking exposure to Brazil would do best to look beyond the major stock index, which is dominated by export-oriented commodity producers such as Petroleo Brasileiro, or Petrobras (ticker: PBR), and mining giant Vale (VALE), to sectors and companies, large and small, that could benefit from rising consumer demand domestically. The big Brazilian banking franchise Itaú Unibanco Holding (ITUB), the Latin beverage behemoth Companhia de Bebidas das Amèricas, or Ambev (ABV), and several educational concerns are on some smart investors' shopping lists.

"You need to be more selective today," says Rudy Martin, president of Latin Capital Management in Jupiter, Fla. "Brazil is no longer a one-decision investment. You need to explore it company by company, considering the sector outlooks, and quality and intentions of management."


Fixed-income investments are another sensible option. Lupin Rahman, a fund manager at Pimco focusing on emerging markets, likes Brazilian government bonds denominated in local currency.

With the central bank of Brazil having cut interest rates by 5.25 percentage points in the past year, to an all-time low of 7.25%, in a bid to spur economic growth, sovereign bonds have rallied. Not only do yields on Brazilian bonds sparkle alongside 10-year U.S. Treasuries, which pay a paltry 1.7%, but "Brazil's creditworthiness is strong and getting stronger," Rahman says.


BARRON'S RECOMMENDED CONSUMER-ORIENTED SHARES last fall in a major look at Brazil ("Better Times in Rio," Nov. 7, 2011), when we said a selloff in the Bovespa amid fears of a recession presented a long-term investment opportunity. The index rallied more than 17% after our story, to about 68,400, before retreating to a recent 58,383. One recommendation, retailer Companhia Hering (HGTX3.Brazil), has performed well in the past 12 months, as has Ambev, whose American depositary receipts rose 21%, to $40.79.

While the recession risk has passed, GDP has increased at a slower pace than expected. A weaker global economy, and China's cooling in particular, hurt natural-resources producers such as Vale and contributed to a 40% drop, to $7.5 billion, in foreign investments in Brazil during the first half of 2012. At the same time, the weak real has crimped Brazilian firms' competitiveness at home by raising their costs.

Above all, emerging-market investors have been spooked by government intervention in key business sectors; the Rousseff administration has tried to influence the price that government-controlled Petrobras can charge for gasoline, and has sought to lower net interest spreads in the banking sector, hurting profit margins. Despite these moves, inflation stands at 5.2%, above the central bank's goal.

CANADA'S BCA RESEARCH HAS been underweight Brazil and other emerging markets for almost three years; managing editor Arthur Budaghyan sees no reason to change his bearish, and prescient, view yet. The just-right, or "Goldilocks" scenario for Brazil is for growth to accelerate while inflation remains stable or in retreat. But Budaghyan gives that prospect only a 5% to 10% probability of materializing. "The underlying causes of capacity strains are a lack of investment and supply-side reforms," he wrote recently. "This is capping the economy's growth potential. As such, odds are that inflationary pressure will rise strongly as soon as growth accelerates."

Recent data, however, suggest that investors are ignoring such concerns. According to numbers from EPFR Global, mutual-fund investors have warmed to Brazil recently, pouring $2.3 billion into Brazil-focused equity funds in the past two months, reversing months of withdrawal.

The iShares MSCI Brazil (EWZ), the largest Brazil-oriented exchange-traded fund, with $9 billion in assets, might look tempting, but its two biggest holdings are Petrobras and Vale. Both have ADRs and are easy for U.S. investors to buy, and neither is expensive. Petrobras fetches 10 times this year's anticipated earnings, and Vale sports a P/E of 9. But both companies face regulatory risks and possible government intrusion, and such concerns won't abate soon.

They also face operational challenges. Brazil has discovered major oil reserves off its shores, but many analysts doubt Petrobras' ability to extract it without problems. Petrobras shares dropped sharply after the company posted disappointing third-quarter earnings Oct. 26.

São Paulo-based Itaú, the biggest private bank in Brazil, accounts for 7.2% of the ETF, and 4.3% of the Bovespa. It is benefiting from rising demand for consumer-banking services, as is Banco do Brasil (BBAS3.Brazil). Both boast strong balance sheets, although Banco do Brasil trades for 5.6 times estimated 2012 earnings, well below Itaú's multiple of 9.4.

Audrey Kaplan, head of equity management at Federated Investors, likes Banco do Brasil and Ambev. The latter might seem pricey at 25 times expected earnings, but it is led by one of the best management teams in the beer business, and is poised to grow earnings by double-digits in coming years.

IF INFLATION BECOMES A PROBLEM next year, as many expect, shopping-mall, toll-road, and property companies could be beneficiaries. Mall operator Multiplan (MULT3. Brazil) is a favorite of Samuel Lieber of Alpine Woods Capital Investors, and toll operator CCR (CCR03.Brazil) is a top pick of UBS. In addition, the government's offer of low-cost credit to students could help boost shares of education concerns.

For many equity investors, the best route to Brazil runs through mutual funds and ETFs. Those looking to play the strong growth in consumer demand in Brazil and elsewhere in Latin America might consider EGShares Emerging Markets Consumer (ECON). The fund has 16% of its assets in Brazil, invests in companies that dominate their respective markets, and is less volatile than the iShares MSCI Emerging Markets Index (EEM). Its biggest holding: Ambev.

BlackRock Latin America Institutional (MALTX) counts Pebrobras and Vale as top holdings, but the fund's 10-year annualized return of 23% puts it in the top 1% among Latin American stock-fund peers.

Small- and mid-cap Brazilian stocks have outperformed their larger cousins this year, due to higher earnings and a focus on local demand. JPMorgan Select Latin (JLTSX) is a solid play on such issues, with 57% of its assets invested in Brazil, including 25% in mid-caps such as retailer Lojas Renner (LREN3.Brazil), which has rallied 59% year to date. Market Vectors Brazil Small-Cap (BRF), an ETF that affords participation in the growing educational sector through its bet on Kroton Educacional (KROT11.Brazil), one of Brazil's largest educational concerns, is another attractive bet.

Market Vectors LatAm Aggregate Bond (BONO) is the largest fixed-income ETF with exposure to Brazil, at 18% of assets, that Lipper tracks, but is only a year old. Mutual-fund GMO Emerging Country Debt (GMDFX) has 5% of its assets in Brazil, but has notched a stellar return over a longer stretch. It is overweight corporate debt.

Brazil remains a compelling growth story, but it doesn't dance to the same rhythm every year. This year has been disappointing, but the beat could grow lively again in 2013.


Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved

November 4, 2012 9:18 pm

On the road again

GM has become far leaner in the US since its bailout but still faces a battle to revitalise overseas businesses such as Opel
Chevrolet Sonic

General Motors’ plant at Lake Orion, 40 miles north of Detroit, is a model of efficiency at a company whose name until recently was a synonym for corporate bloat and profligacy.

Car workers installing wiring, air conditioning and other components pick up kits of parts prepared for them by contractors working just a few yards away. The workers then step on to a conveyor belt carrying the cars and install the parts under the bonnets or inside the footwells. They then walk back, ready to start on the next vehicle. Every process in the area, known as the trim shop, minimises time and waste.

Click to enlarge

According to Steve Brock, the plant’s manager, the Lake Orion plant only recently began running such a tight ship. Before GM reorganised in bankruptcy in 2009, the plant had a less efficient assembly line. The old equipment, millions of extra dollars-worth of it, snaked twice the distance around the trim shop. Contractors worked at a site several miles away.

“[Now] they’re just next door, instead of 10 miles away,” Mr Brock says. “It helps from a quality perspective and from a cost of inventory standpoint.”

The Lake Orion plant is a microcosm of many of the positive changes at GM, America’s biggest carmaker by revenues – and one of the world’s top three by unit sales. Following the US Treasury’s $49.5bn bailout of the company in 2008-09, it is on a new course.

Just over three years after it exited bankruptcy, the company has lower costs, a balance sheet unburdened by crushing debt and flexible labour agreements that have made it more competitive. GM last week reported third-quarter net income of $1.5bn, its 11th straight quarter of profitability. Dan Akerson, chief executive, brandished a slide showing upward-pointing green arrows on eight out of 11 financial metrics the company measured for the quarter, which included global sales, earnings and net cash.

The company – like Ford Motor before it – is working to make better use of its international network of engineers and manufacturing plants to take on its main rivals in the business, led by Toyota and Volkswagen. This, coupled with having lower costs and a better financial footing, means GM for the first time in decades is producing cars that can compete effectively in the US against overseas manufacturers.

The Lake Orion plant makes the Chevrolet Sonic, a surprise hit for GM. Since its launch last year, the car has grabbed more than 10 per cent of the subcompact car market in the US, a segment where GM could not compete a decade ago because its costs were too high. The Sonic is selling better than competing small cars such as the Honda Fit, Hyundai Accent, Toyota Yaris, and even Ford’s small Fiesta, which it makes in Mexico. “The Chevy Sonic is probably one of the best small cars on the market, if not the best,” says Michelle Krebs, senior analyst with, the US carbuying website.

However, an objective report on the health of GM would have to raise questions on whether the company is fully healed.

While it is one of the industry’s top-selling producers, it still makes less profit per vehicle than VW, Hyundai-Kia or Ford. This could matter over time – and potentially push GM into losses – in a brutal global business where all of its competitors are raising their game significantly too.

In Europe, GM lost time during the bankruptcy when it fumbled badly on an attempt to restructure Opel/Vauxhall, which will lose $1.5bn to $1.8bn this year. GM’s losses in Europeone of the few red arrows on Mr Akerson’s chart last week – have been weighing on its profitability to the point that its shares are trading well below its initial public offering price of 2010. This means US taxpayers are unlikely to see the 32 per cent remaining government stake floated any time soon. If not, GM’s derisive nicknameGovernment Motors” – usually invoked when doubts are raised about its viability – could still stick for some time.

Questions also persist over whether Mr Akerson, who came to GM via the telecommunications industry and private equity, is the right man for the job. Unlike his two big rival chief executives in Detroit, he has not articulated a simple and punchy message to investors on where he wants to take GM. Ford’s Alan Mulally has a mantra of “One Ford”, predicated on marshalling the carmaker’s global assets to produce a globally similar, regionally customised stable of vehicles built on shared platforms. Sergio Marchionne’s message at Chrysler is that he is coupling that carmaker’s management and car platforms with Fiat’s.

Some of Mr Akerson’s recent appointments have also raised eyebrows. In October, GM named Robert Ferguson, its chief lobbyist, to run its Cadillac premium brand, with a challenging brief to grow the brand globally and take on the industry-leading German brands. GM has not named a marketing chief to replace Joel Ewanick, who stepped aside in July.

The area is seen as one of GM’s weakest. “We haven’t seen cohesive marketing messages from any of their brands,” says Aaron Bragman, senior analyst with IHS Automotive. The company’s cap on salaries, imposed as part of its federal bailout, is hindering its ability to hire the best in the business.

GM’s post-bankruptcy health is also a focal area of argument in the run-up to Tuesday’s presidential election. Mitt Romney, the Republican challenger to President Barack Obama, has insisted that the intervention to save GM and Chrysler was too costly. He has since said he would have supported government backing for some of the debt needed to bankroll the two carmakers’ reorganisation, but would have expected the private sector to provide the financing itself.

The Obama administration, by contrast, has trumpeted the US auto industry’s renaissance as one of its biggest achievements. Joe Biden, the vice-president, in his current stump speech, sums up the administration’s achievements: “Osama bin Laden is dead – and General Motors is alive.”

. . .

While the White House claims credit for turning round GM, some of the changes now bearing fruit at the company were already under way before the banking crisis pushed it into insolvency in late 2008, in the final days of George W. Bush’s administration.

Before the bankruptcy, GM had joined Ford and Chrysler in negotiating to spin off their massive healthcare liabilities to funds managed on behalf of United Auto Workers. This allowed GM and its rivals to lower their costs per vehicle. In 2007, the union also signed off on a two-tier wage regime for new hires. Many workers at Lake Orion are on lower pay than their longer-serving colleagues, allowing the plant to make the Sonic and compete in the growing US market for small cars.

However, since exiting Chapter 11, GM’s three post-bankruptcy chief executives most recently Mr Akerson – have sharpened the company’s focus on tailoring vehicles to customers’ needs, producing them competitively and using the worldwide resources of its engineers and designers, from Detroit and Rüsselsheim, Opel’s home town, to Shanghai and South Korea.

Mary Barra, GM’s head of product development, says the company has closed what she admits was a gap in quality of its new vehicles, compared with competitors. She attributes the improvements to technical and logistical factors. “There’s no one silver bullet,” she says. “It was back to basicsengineering, designing for quality.”

Third-party assessments bear this out. According to, Cadillac and Chevrolet have steadily improved the prices their used cars command – the surest sign of how the market values a brand – in 2010, 2011 and 2012.

Buick and GMC, GM’s pick-up truck brand, improved their prices in two of the past three years. “From a product standpoint, they have been fixed,” says IHS’s Mr Bragman. “We are seeing product that is finally fully competitive.”

GM’s business has also profited from the depth and toughness of the Obama administration’s restructuring of the car industry, which saw Washington impose demanding business plans on all three Detroit carmakers, forcing them to close a swath of plants as a condition of the bailout. This has helped all US-based producers’ profitability by reducing pressure on margins caused by a saturated market. It contrasts with the crisis levels of overcapacity in Europe, now hurting Opel, among others.

Steven Rattner, who lead the US Treasury taskforce that restructured GM says: “On balance, in total GM is outperforming our expectations”.

With GM’s core business in fitter shape than it has been in years, its biggest challenges are overseas. After botching its first restructuring at Opel, GM has poured resources into an effort to fix the unit. Steve Girsky, Mr Akerson’s deputy, who was named last year to chair its supervisory board, has stocked it with managers from Detroit. These include Ms Barra, Dan Ammann, chief financial officer, and Tim Lee, head of GM’s manufacturing international operations, including its China business. To begin restoring pricing power in Europe’s depressed market, Opel has reduced unprofitable sales channels such as rental car companies.

It is also seeking to win back German buyers disenchanted by its recent problems; and says just 10 cars have been returned out of 25,000 sold in a “Thrilled or Just Return Itmarketing campaign. GM is also pooling logistics, purchasing and vehicle development with its new ally PSA Peugeot Citroën in an effort that it says will save each carmaker $1bn by 2016. Last week Mr Girsky spoke of “green shoots sprouting in the mud” at Opel, saying it would begin narrowing its losses next year and break even by the middle of the decade.

. . .

GM also has work to do in Asia and South America, where its powerful positions in China and Brazil are coming under threat from competitors angling for bigger shares of the global industry’s two biggest growth markets. Elsewhere in Asia, Chevrolet’s core manufacturing operation in Korea faces strong labour unions, and GM is struggling to reduce costs.

As it faces these threats, GM is touting advantages it says will allow it to stay the course: converging global consumer tastes in cars that will favour its geographical reach; a strong product pipeline; and what Mr Akerson last week called a “fortress balance sheet”. As the company invests, he added, “we are confident we will improve our margins by the middle of the decade”.

Given GM’s turbulent recent history and the tough, cyclical industry in which it operates, investors might be forgiven for being less bullish than GM’s chief executive. However, industry experts do not predict that the company will become a burden on US taxpayers again any time soon.

Copyright The Financial Times Limited 2012