Hedge-Fund Titan Sees Brazil in a ‘Gray Zone’ Even With Reform

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Hedge-Fund Titan Sees Brazil in a ‘Gray Zone’ Even With Reform

(Bloomberg) -- Brazil’s plan to overhaul its pension system has become a make-or-break issue for markets, which rally on signs of the bill’s progress and sink on its setbacks. But for one of the nation’s most revered hedge-fund firms, the biggest concern lies in what comes next.

“The government will probably deliver something acceptable in terms of pension reform, but I’m a little worried on what you’re going to get afterward,” said Leonardo Linhares, a partner at SPX Capital, Brazil’s biggest independent hedge-fund firm with almost 40 billion reais ($9.9 billion) under management. “I’m not optimistic about the next steps.”

Linhares, who runs the equities desk at SPX, says the government will likely burn through a lot of its political capital to push the unpopular reform through Congress. That means anything else on the economic agenda that depends on lawmakers’ approval will be tough to pull off. Without those micro-reforms, which include changing Brazil’s cumbersome tax system, privatizing state-owned companies and selling other government assets, it’s unlikely the country will have a growth spurt over the next years, according to him.

The pension system overhaul is the cornerstone of the government’s plan to trim the size of the state and shore up fiscal accounts. The reform has had a bumpy start in Congress, taking weeks to clear the first lower house committee amid fierce pushback from the opposition and a lack of coordination from the government’s base. Now, it’s before a so-called special committee, where it’s likely to undergo changes.

Gray Zone

SPX is expecting pension reform to be approved by the lower house late in the third quarter, with savings of less than 600 billion reais in a decade -- compared with an original proposal of more than 1 trillion reais. That should pave the way for the economy to grow around 2% a year in the short term. Latin America’s largest economy will expand 1.23% this year, according to the median forecast from economists surveyed by the central bank, half of what they expected three months ago.

“We don’t believe Brazil will go bust, but it won’t be a walk in the park either: We’ll get into a gray zone” said Beny Parnes, the fund’s chief economist. “I don’t see a big confidence boost coming. We’re masters of muddling through in Brazil.”

The reason for disappointing growth even with a long period of record-low borrowing costs is a bit puzzling to Parnes. Uncertainty may be part of the explanation, as the private sector is still holding back from filling the gap left by the government’s retrenching. But the former central bank director attributes part of the blame to some unknown factor he dubbed the “little phantom.”

“There’s something dragging down the economy, it should have been recovering at a faster rate. And we don’t know what this little phantom is,” he said.

Still, Parnes sees some bright spots ahead, especially from the flurry of deals set to happen in the energy sector as the government lines up several oil field concessions. He also praises the work of Bolsonaro’s economic team, led by minister Paulo Guedes, who he says “is doing three different jobs for a single wage:” the economic policy ideologue, the one coming up with ways to execute those views and the one negotiating with Congress -- an arena plagued by infighting between the government and key allies.

Not as Cheap

Weaker-than-expected growth, the back-and-forth on pension reform and trade war concerns have led Brazil’s benchmark equity index Ibovespa to pare its year-to-date gains. Since its peak in mid-March, the Ibovespa is down 11% in U.S. dollar terms.

Linhares says he’s taking a more neutral stance on domestic stocks now, with shares “not as cheap as some people say.” In a recent note to clients, SPX said it had scrapped its net long position in Brazilian equities, keeping only its bet that utilities and oil and gas firms will outperform the Ibovespa.

The firm’s flagship Nimitz fund has had a total return of 251% since its December 2010 inception, nearly double the benchmark.

“I’m not a pessimist, I think pension reform will guarantee Brazil two, three years of growth,” Linhares said. “But unfortunately we’re missing an opportunity for more.”

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