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Brazil Stock Market Tanks Amid Petrobras Scandal That Keeps On Giving

Well, that didn’t last long. Brazil is no longer the darling of emerging markets, with stocks crashing over 5% on Friday . Blame the political class, again.

There are two reasons for today’s correction. One was an immediate over-reaction to news headlines, the other is a rethinking of key market-friendly reforms needed in Brazil this year.

Yesterday’s arrest of former president Michel Temer reminded everyone that the Petrobras Car Wash scandal, the very scandal that led to two years of recession and a never-ending political crisis, will pull the rug out from under this country in seconds flat. Brazil stocks are now underperforming. But just wait until investors price in a failed pension reform, which is probably just three months away. I think that is already starting to happen and Temer’s arrest was just reminder that Brazil is in crisis-mode, making it difficult to govern.

Temer was pulled in on Thursday by Federal Police officers for his role in the Petrobras crime spree. They said he helped run an “organized crime” ring within the government: a system of pay-to-play contracts with civil engineering firms like Odebrecht building all sorts of stuff for Petrobras and skimming millions of dollars off the top. Dozens of A-list executives have been jailed now for at least three years. And yadda yadda yadda. … Temer was next in line.

To date, of the top political leaders in charge during the Petrobras contract-rigging scheme, only ex-president Dilma Rousseff is still standing. She desperately tried to become senator of her home state of Minas Gerais last October but came in third place, probably not because she loved politics or had nothing better to do for work. Now that she is a private citizen, like Temer, she has lost political immunity.

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Temer: Petrobras presidential jailbird No. 2. AP Photo/Eraldo Peres

Dilma was impeached in a somewhat farcical April 2016 vote by the lower house of Congress for breaching budget laws. She was later indicted in August of that year, making her vice president, Temer, the new interim President. Her impeachment had nothing to do with Petrobras, though the people who instigated it did, with one of them, House Speaker Eduardo Cunha … in jail.

Brazil spent much of the last two and a half years in political chaos because of Petrobras.

Temer was the most disliked president in Brazilian history, with an approval rating struggling to get over 10%. When the election season began in 2018, it became clear that no one from the parties associated with Petrobras was going to win.

They tried hard. Lawyers for jailed ex-president Luiz Inacio Lula da Silva worked overtime trying to convince the United Nations and media influencers from London to New York that he was an innocent man, jailed for his politics. His handpicked successor was Dilma. His second handpicked successor was a former São Paulo mayor, Fernando Haddad. Haddad took it upon himself to admit that he was not his own man, even going so far as printing up and wearing T-shirts emblazoned with the ridiculous campaign slogan: “Haddad is Lula.” He visited Lula in jail for campaign advice. And so as while rubbing the face of the electorate with indicted Petrobras criminals, Haddad got beat by a family-values conservative named Jair Bolsonaro who symbolized the boiled-over anger of those who had had it with anyone affiliated with embattled oil company.

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A supporter of former Brazilian president Luiz Inacio Lula da Silva cries in hopes of his release outside the federal police department where Lula is serving a 12-year sentence for corruption in Curitiba, Brazil, on  Dec. 19, 2018. No one has heard from him or about him since the start of the new year. AP Photo/Denis Ferreira

By The Way, Where’s Lula?

Lula has been totally absent from the headlines. The biggest fish fried by the Federal Police made himself part of the daily news cycle in the fall of 2018. The New York Times gave him op-ed space where he sold his political persecution story to the world. (I tried to get an opposing view in the NYT, arguing that he was not a political prisoner, but they rejected it. Tudo bem.)

Now, the disgraced founder of the Workers’ Party is spending the next 12 years in jail, at least. No one is outside his prison quarters cheering “Good morning, president Lula” anymore. He is alone and—mostly—forgotten.

His lawyers are no longer blasting reporters’ Whatsapp accounts with their latest filings of a habeas corpus or a statement by someone who works for the UN Human Rights Commission saying that the Petrobras investigators used their legal powers to jail him unlawfully. Those days are suddenly gone. And they are gone, obviously, because the election is over and the Workers’ Party lost. Lula’s “political persecution” was what it was: a political campaign for the Workers’ Party.

The Car Wash investigation isn’t picking parties to plunder.

Temer’s Democratic Movement Party, a big-tent party of wealthy Brazilian oligarchs, one of the oldest parties in the country, also lost big in last year’s election because of Petrobras. In fact, every party that was part of the government, even those that were part of the majority opposition, got handed their walking papers because of this scandal.

It is no surprise that Temer was arrested. If the courts don’t get you, the voters will.

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Supporters of presidential candidate of the Workers’ Party Fernando Haddad, dressed in a banner written in Portuguese: “Haddad is Lula 13. AP Photo/Eraldo Peres

Brazil’s new government rose to power out of sheer hatred of politicians like Temer and Lula. But this new government is surrounded by noise. Temer’s arrest will likely push Bolsonaro’s already declining public opinion polls lower, especially if Brazilians do not see their economic outlook improving.

Some 68% view Bolsonaro as either “good” or “very good,” with numbers for “very good” declining 15 points since his inauguration in January.

At the start of the year, Jan Dehn, head of research for the Ashmore Group, a $74 billion emerging markets asset manager in London, told me he was giving Bolsonaro until the end of the first half to get something done — on pension reform, in particular. That has been the one issue propping up Bolsonaro’s stock price. As soon as the market feels pension reform is in jeopardy, Brazil’s stock market turns the other way, and Bolsonaro is governing over political crisis and weakening investor sentiment, not much different than Temer did.

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Jair Bolsonaro, Brazil’s president, said of Temer’s arrest: “Each person has to be responsible for their actions.” Andre Coelho/Bloomberg

© 2019 Bloomberg Finance LP

Bolsonaro: Governing Above The Noise

It is difficult to govern in Brazil due to all the different political alliances. This is not a two-party system. Considering the difficulties already involved in the Brazilian congress, throw political crisis on top of that and it becomes even harder.

Bolsonaro was relatively quiet on Temer’s arrest, preferring to say that, “Each person should be held responsible for their actions.”

Bolsonaro wasn’t elected on an economic platform. He was always an anti-Lula, law-and-order vote.

His government’s economic team is led by BTG Pactual founder Paulo Guedes, a University of Chicago-educated markets guy who has set the course for a somewhat overambitious list of economic reforms. Bolsonaro basically put Guedes in charge of the market.

Given the complex process in approving Guedes’ measures, from pension reforms to privatization, delays are more likely today because of uncertainty surrounding Petrobras investigations than they were last week. The Car Wash investigations are not over, and that means key members of congress could, in theory, be focused on other matters, or perhaps, lose their post in key cabinet positions in worst case scenarios.

Bolsonaro’s small political party—the Social Liberal Party—was not part of the Petrobras scandal, so it is possible they will not be scrambling like the congressional leaders were under Temer’s Administration when arrests were made of private citizens affiliated with them.

On the bright side, that means Bolsonaro has a better chance to inoculate himself from the Petrobras-related arrests like the eight individuals arrested on Thursday.

If he can do that, then smaller reforms like payroll tax breaks and Petrobras asset sales might get done earlier this year. Pension reform is unlikely to go anywhere until the end of the year, Morgan Stanely analysts said in a report. This is a very different view from a month ago when consensus estimates were for some type of pension reform to be competed by July.

The rest of Bolsonaro’s economic agenda depends on how well he can separate himself and his team from the Petrobras brat pack. He will have to remind them that he is president because he was never part of that group in the first place.

For media or event bookings related to Brazil, Russia, India or China, contact Forbes directly or find me on Twitter at @BRICBreaker

I’ve spent 20 years as a reporter for the best in the business, including as a Brazil-based staffer for WSJ. Since 2011, I focus on business and investing in the big eme…

Source: Brazil Stock Market Tanks Amid Petrobras Scandal That Keeps On Giving

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The Yield Curve Just Inverted, Putting The Chance Of A Recession At 30%

The interest rate on the U.S. Treasury 10-year bond just fell below the rate on the 3-month bill in response to the Fed’s March announcement. This is called yield curve inversion as defined by Arturo Estrella and Frederic Mishkin. It implies a 25%-30% probability of a recession on a 12-month view. Their research can be found here.

As economic relationships go, the yield curve has a good track record. You can see the data below going back to 1982. Per the chart, using this series over recent history, the yield curve inverts before a recession reliably with no false positives. An impressive record. The blue line shows the spread between 10-year and 3-month interest rates. The black line is the zero bound. The shaded grey periods are historical recessions. Note that there is a lagged relationship here, recession historically occurs 6-18 months after inversion. So today’s yield curve suggests a fair chance of a 2019-2020 recession.

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Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity

Federal Reserve Bank of St. Louis

Risks Of Interpretation

Nonetheless, there are some risks with this approach. The first is we’re looking at a limited run of data. There are only a few decades in the sample and a handful of recessions. We’re making a forecast here based on less than ten recessionary events, per the initial research and subsequent out-of-sample data. Plus there are countless pieces of economic data out there. Combining two of them and creating a good recession forecast is possibly due to data mining. For example Tyler Vigen’s site illustrates the problem, showing how correlations can be found between many things that have little basis in reality, such as an apparently strong relationship between mozzarella cheese consumption and sociology degrees. So even though the yield curve relationship looks robust, it has been plucked from hundreds of other relationships that could exist, but don’t look as meaningful. The human brain is adept at creating patterns where none exist.

Also, a 25-30% chance of recession is not that high. Going back from 1960 to 2018 we have 59 years of data. We’ve had U.S. recessions during 16 of those years. So even before any more sophisticated forecasting methods, your chance of being in a recession in any given year are 27%. There’s some auto-correlation there too, as recession years come in clusters, but still, saying the chance of recession coming within a year or so is around one in four isn’t that different from what history tells us regardless of what the economy is doing. Of course, even at a 30% probability the chances are roughly twice as high that a recession does not occur.

Also, the Federal Reserve (Fed) has a key target of avoiding a recession in order to maintain full employment. This one of their key policy targets. The Fed are quite capable of learning. The increasing emphasis on the yield curve has not gone unnoticed by the Fed. In fact, the initial research here was published by the New York Fed itself. So unlike in the past, the Fed may be able to take corrective action, which was exactly what Chairman Powell was looking to stress in the Fed’s March meeting release. The Fed’s challenge is obvious but not simple, a few quarters ago the markets were spooked by a potential stack of rate hikes in 2019 that could risk recession, so the Fed changed course. Yet, in doing so they have helped create an inverted yield curve, introducing another set of recessionary fears.

However, the risk here is the markets are capable of learning too, and there is some evidence that recessions are self-fulfilling, meaning that if enough decision makers expect a recession they may then take the very actions actions, such as temporarily cutting back on spending, that cause a recession to happen. In that light, yield curve inversion gaining more attention is bad news if it causes people to anticipate a recession, which then makes one more likely.

So yield curve inversion is not a positive sign for markets, but we may be overstating its importance. Also if the indicator is to be believed, we should watch out not just for inversion, but when the 3-month yield falls 1% or more below then 10-year yield, then our confidence in a recession around the corner should be quite a bit higher.

Articles educational only, not intended as investment advice.

Follow @simonwmoore on Twitter. Simon is Chief Investment Officer at Moola, and author of Digital Wealth (2015) and Strategic Project Portfolio Management (2009).

Source: The Yield Curve Just Inverted, Putting The Chance Of A Recession At 30%

Barclays’ Smoke & Mergers Will Not Deflect Tough Questions – Nils Pratley

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Chairmen, especially those embarrassed by the share price on their watch, feel obliged to examine any old merger or acquisition idea. But there are limits to what counts as credible and Barclays’ John McFarlane was seriously off-piste if he thought shareholders would be remotely interested in a corporate combination with Standard Chartered.

The idea provoked inevitable derision in the City. First, Barclays’ entire strategy for the past three years has been to reinvent itself as a US-UK “transatlantic bank”, minus its former African business. Merging with Standard, which operates almost exclusively in Asia and Africa, would be a U-turn too far. Second, regulators would probably demand substantially bigger capital buffers, thereby negating the appeal of Standard’s Asian deposit base. Third, the potential to rip out costs, banks’ usual justification for big mergers, would barely exist.

Barclays’ “exploratory conversations”, according to the FT’s report, were prompted by the perceived need to have a plan B to hand when the unsmiling agitator Edward Bramson turns rough. Bramson’s Sherborne fund has bought a 5.4% interest in Barclays and a confrontation of some form is inevitable because that is how activists justify their fees.

McFarlane and colleagues should drop their “blue sky” bumbling. Barclays’ share price, stuck around the 210p mark, is unimpressive but a panicky mega-deal could make things worse. Their thinking should be simple. If the board trusts the chief executive, Jes Staley, to grind out higher returns over time, let the strategy run. If it doesn’t, it should not have approved his plans in the first place.

Bramson’s beef is assumed to be about Barclays’ investment bank. Should the bank even be in a capital-hungry business dominated by big American firms? Bramson will probably offer a few sharp criticisms and, actually, it’s right that Barclays should be made to explain why dismantling its unreliable investment bank is supposedly too expensive to contemplate. But give the detailed rebuttal, don’t play silly games of fantasy mergers.

Most of all, remember that Bramson is merely a 5% short-termist punter who may have overreached in trying to call the tune at a large regulated bank. He should not be a source of terror.

M&S has time to save itself

It was a “historic day” for Marks & Spencer, declared the chairman, Archie Norman, and he wasn’t talking about the record £514m “adjusting item” hit to profits, which beat even last year’s £437m whack. Rather, M&S was offering the first warts-and-all assessment of its troubles for ages, Norman said.

The list of woes was certainly long: too many stores; stores in the wrong places; a website that is too slow; a distribution centre that cannot cope with peak demand; dated IT systems; an inefficient supply chain in food; and, as the chief executive, Steve Rowe, put it, a corporate culture that was “top heavy” and “inward looking”. Given that none of those items can be considered minor, you can understand why the promised turnaround is pitched as a “three-to-five-year” job.

The share price rose 5%, probably reflecting M&S’ confidence in a same-again dividend of 18.7p. The yield is 6% if you believe the annual distribution is permanently safe. That’s not the worst long-term gamble in a horrible retail sector, even if one suspects more than 100 stores will eventually have to close. M&S still has time to save itself.

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