Portfolio Update: Brazil

Brazil is the largest position in the portfolio by a significant margin, as OM feels it’s in that sweet spot when all of the relevant factors all line up.  Given how out-sized it is in the portfolio, Brazil is getting its own little write-up

Brazil: 25.8% (International Book) as of 9/30/17
The long-term argument is simple; Brazil’s long recession, and the equity bear market that lasted from 2011 to 2016 which saw an almost 80% loss (in USD-terms) is over.  The market bottomed in Jan-16 and a new cyclical (possibly event secular) bull market is beginning.  Furthermore, the public discourse around Brazil and investor sentiment reached a nadir in Q2-16 as the ‘Carwash Scandal’ enveloped the ‘elite’ business and political class culminating in the successful impeachment of President Rousseff.

So why invest?  Well, the highest return potential is when a situation improves from one that is terrible and completely ignored by investors, to one that’s ‘okay’ and attracts curious interest.  There were clear signs of this in Brazil during the middle of 2016 across a range of areas;

- At a macro level the balance of trade turned positive (historically a very good sign for Brazilian equity markets). 

- President Temer, the new President was viewed as a short-term President, and with politicians already held in contempt by the populace they were ironically more amenable to taking actions (i.e. economic and pension reforms) that they normally tried to avoid. 

- At a corporate level, both friends and professional contacts of OM said similar things; that companies, irrespective of sector, had to cuts costs to the bone to survive the last 5-years.  Many only survived as a result of competitors going out of business.  Or in layman’s terms, if there were any growth in demand these firms have a better competitive position and operating leverage! 

- While speaking with numerous Brazil-focused portfolio managers, Our Man kept hearing that fundamentally stocks (especially outside the most liquid names) were exceptionally attractive but…

The phrases after the “but” always represented the various constraints - self-confidence after a bear market, market concerns, what clients would think, potential business risk, etc. - that prevented the portfolio manager from participating (for now, in OM’s view).

- Finally, after a seemingly continuous fall the Brazilian market (in USD-terms) finally started to turn around, impulsing higher in early and mid-2016 and leaving the lows well behind. 

With this mix of promising signals, and the opportunity created by a short-sharp pullback in the wake of the US election, Our Man began his Brazilian position split between large-caps (EWZ) and small-caps (EWZS) in late-2016.

The data over 2017 has largely started to confirm many of the original premises.

- As noted, in the Q2-review, President Temer’s probability of being a short-term President increased after he was allegedly caught on tape discussing hush-money payments to jailed powerbroker Eduardo Cunha.  The entire process, which ended with him surviving an impeachment vote, ensured the public’s low esteem of politicians remained unchanged.  Yet, the probability of reforms passing increased with him surviving impeachment.

- Temer’s troubles led to a 20% pull back in May, which saw a subsequent bounce before retesting the May lows before rallying once more.  This created the technical sign for Our Man to add to his position, before adding once more as the rally went through the highs seen in May.

- The economy continues to improve on multiple fronts, be it GDP finally turning positive 

or inflation falling dramatically

or the balance of trade looking the healthiest in years.

In summation, to Our Man’s mind, Brazil is setting up as a perfectly positive storm of fundamentals and technicals meaning OM sees a de-risked (for example, versus 12mos ago) situation that is getting ready to continue its sharp rise.  Unless he’s horribly wrong and the Q2 lows are tested, OM hopes that despite the inevitable volatility he won't even be trimming his positions back till they're significantly higher or Brazil’s 2018 election is in he headlights.


Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take the above that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.  

2017: Third Quarter Review

There were a number of changes to the portfolio during the quarter.  A brief summary is below, but expect a broader portfolio review (likely in multiple parts) in the coming weeks.

International: 
- Added to Brazil (EWZ & EWZS): As readers will remember, Brazil fell heavily in mid-Q2 after recorded conversations (re. accepting a bribe) involving President Temer led to an impeachment attempt and potential criminal charges.  In mid-to-late-July, it became clear that these charges wouldn’t be accepted by the lower house of Congress (subsequently confirmed by a vote in August) and in late August the Brazilian market broke out to new highs.  OM added to the Brazil position on each of these events (in larger size on the breakout to new highs).  This makes Brazil the largest position in the portfolio.
- Bought India (INDA & SCIF): OM started a small position in India.  He’s been looking at it for a while, as it’s somewhere that’s likely a multi-year holding but was always too price sensitive.  Call this a first nibble at what might one-day be a much larger position.
-  Bought Greece (GREK & ALBKY): OM’s previous investments in Greece have been far from stellar (i.e. terrible) yet he returned to that poisoned chalice just before quarter-end.  Why now?  Time (and recapitalizations) help heal balance sheet wounds, and there was a small (under-reported) catalyst on debt reduction.  The initial position is very small - it would have to triple to cover prior losses - but the return potential is substantial and OM thinks the market is over-stating the risk.
- Exited Italy (EWI): OM exited the Italy position.  It has performed well, but other opportunities (i.e. Greece) are just more attractive at this point.

Equity: 
- Exited Dollar Tree (DLTR): While Dollar Tree is a beneficiary of tax reform (if it comes), with Amazon’s purchase of Whole Foods and stronger ideas out there, it was an easy sell.
- Exited Liberty Broadband (LBRDK):  This was actually the toughest decision in the portfolio, since Charter Communications (LBRDK just owns Charter and a subsidiary) is a fantastic business with good opportunities ahead of it.  There are some very good public write-ups about why Charter Comms (and thus LBRDK) will be worth substantially more in the future, and OM largely agrees with them.  In the end there were just things OM has greater confidence in.
 - Bought Texas Pacific Land Trust (TPL):  TPL is a publicly traded land trust that’s self-liquidating as it buys back shares with excess cash.   The trust benefits primarily from oil & gas royalties (the Trust’s land is located in the Permian basin), which have risen over the last 4-years even as the oil price has fallen.  Interestingly, in the middle of the year the Trust announced the formation of a subsidiary to provide water resources.  Given TPL owns the water rights under its land, there is opportunity to supply water to drilling companies and find ways to recycle the (non-potable) water that’s a byproduct of drilling. 

Currencies 
- Exited Short Euro (EUO): Our Man exited the short Euro trade in mid-late August.  Though it’s been a fantastic contributor over a number of years, the end was bittersweet – as noted previously, it should have happened earlier in 2017.  The exit also marked the end of Our Man’s dollar bull thesis – in its various guises (and including the Short Australia dollar positions, within the China Thesis) it ended up contributing over 1,000bps to performance!  It should have been more 😔...

China Thesis: 
- Added to Chinese A-Shares (ASHR):  Our Man materially added to the A-shares position during the quarter.  China is a swirling surfeit of liquidity seeking somewhere to call home, drive up prices and then move on once more when the authorities play whack-a-mole.  We've seen it at least once each in real estate, domestic equities, commodities, and most recently bitcoin.  With the authorities making it harder to invest in bitcoin (the latest home), the liquidity is on the hunt once more.   OM is wagering that the 19^th National Congress starting in Q4, will offer the stability for local equities to shine once more after the boom/bust of 2015.  Technically, they’re setting up well and OM wouldn’t rule out a run at 2015 (or even 2007) highs.
- Exited Short Australian Dollar (CROC):  Much like the short Euro position, OM exited this position during the middle of the quarter.  Unlike the Euro position, the sin wasn't holding it too long, it was re-entering/sizing it in Q2 despite the technicals looking unattractive.

Commodity: 
- Added to Uranium (URA):  OM sized up the position in Uranium mining companies (URA) after the recent pullback held above its 2016/2017 lows (spot uranium also held above its 2016 lows).  This coupled with Japanese power plants slowly coming online and the supply discipline holding creates an interesting opportunity.

Performance and Review 
The second quarter saw OM’s portfolio rise 512bps, while the S&P 500 (TR) rose 4.5% and the MSCI World was up 4.1%.  For the year, this left OM’s portfolio +13.4% compared to +14.2% for the S&P 500 (TR) and +13.0% for the MSCI World.  

Performance was driven by the International/Country book (+476bps), with Brazil being the primary contributor (just over 300bps).  As noted above, Brazil bounced back sharply from Q2’s Temer-related fall, and OM was helped by added to the position in the quarter.  Argentina and Italy were also healthy contributors.

The Technical book (+124bps) was a direct beneficiary of the market rise.   The Funds book (+39bps) also rose with the market, though it underperformed during the quarter but remains comfortably ahead of the market in 2017.  The Equity book (+14bps) was only a marginal contributor with negative performance from Vipshop Holdings (VIPS, -59bps) offsetting most of the gains driver by Liberty Broadband (LBRDK, +36bps) and Biotech (IBB, +34bps).

The China Thesis (-42bps) and the Currencies book (-81bps) both detracted from performance due to the long Dollar exposure before those positions exited the portfolio.  Finally, the Commodities book (-18bps) hurt as Uranium stocks continued to muddle around.

Portfolio (as at 9/30 - all delta and leverage adjusted, as appropriate)
41.4% - International (Brazil, Argentina, India and Greece)
25.7% - Technical (DDM, QLD and SSO)
15.9% - Equities (JD, VIPS, TPL, FNMA & IBB)
10.3% - Funds (CWS, GVAL, and CAPE)
9.4% - China-Related Thesis (ASHR)
7.3% - Commodities (URA)

2.9% - Cash  

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take the above that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.