Short Sales Double as Profits Tumble: Corporate Brazil

Short sellers in Brazil, whose favorite targets tumbled five times faster than MSCI Inc.’s country stock index this year, are boosting bearish wagers to a record after valuations rose to the highest levels since 2008.

MSCI Brazil (MXBR) Index shares on loan more than doubled in the past 12 months to 5.9 percent of stock available for trading on April 19, the most since Bloomberg began compiling the data in 2010. Corporate profits fell 36 percent in the period, exceeding the index’s 5.2 percent drop and sending the price-to-earnings ratio to a level last reached at the market peak in May 2008.

Bets against companies from Eletropaulo Metropolitana Eletricidade de Sao Paulo SA to PDG Realty SA are growing as government intervention, accelerating inflation and falling commodities spurred the biggest earnings drop in emerging markets. While stocks are posting the longest rally since September and former central bank President Arminio Fraga says investor pessimism is overdone, forecasters who predicted the retreat at Marketfield Asset Management and Deutsche Bank AG say losses will continue as consumer spending wanes and China’s economic slowdown curbs exports.

“I don’t think we’ve put in the ultimate low,” said Michael Shaoul, the New York-based chairman of Marketfield Asset Management, whose $8 billion MainStay Marketfield Fund has outperformed 95 percent of peers tracked by Bloomberg during the past 12 months. His firm started betting on declines in Brazilian shares in mid-2011, Shaoul said in an April 24 phone interview.

Prescient Trades

Short sellers have proved prescient this year. Companies in the MSCI Brazil gauge with the highest percentage of shares on loan at the end of December dropped an average 19 percent, with eight out of 10 stocks posting declines, data compiled by Bloomberg show. That compares with the index’s 4.3 percent decline in local-currency terms and an average gain of 6.8 percent for the least-shorted shares.

The 69-stock Ibovespa (IBOV) gauge is down 9.8 percent this year after gaining 4 percent in the past five days, as commodities rebounded and the government announced tax breaks for industries including petrochemicals. The benchmark rose 0.4 percent to 55,196.02 at 2:23 p.m. in Sao Paulo today.

Short interest as of April 23 was about 5.5 percent of shares available for trading, or float, in the MSCI index, data compiled by Bloomberg show. In a short sale, traders sell borrowed stock, anticipating the price will drop so they can profit by buying back the shares at a lower price.

Earnings Outlook

The increase in short selling could indicate a lack of certainty about earnings or Brazil’s economic outlook and policies, according to Otavio Vieira, who helps manage 330 million reais ($164 million) as a partner at hedge fund Fides Asset Management, which shorts stocks as part of its strategy.

“We’re probably still going to have some effects of the slow growth last year in first-quarter earnings, with some companies having difficulty meeting their guidance,” he said by phone from Rio de Janeiro.

Equity loans may also be used to implement arbitrage strategies or fulfill an obligation to deliver the securities to settle another transaction, according to the website of BM&FBovespa SA (BVMF3), operator of Brazil’s exchange.

Eletropaulo tumbled 52 percent this year as short interest increased to 28 percent of float, the highest level in the MSCI index, from 23 percent at the end of December.

Interventionist Government

PDG Realty, a Rio de Janeiro-based homebuilder, retreated 29 percent as short interest increased to 19 percent of float from 9.5 percent at the end of 2012. OGX Petroleo & Gas Participacoes SA, the Rio de Janeiro-based oil producer controlled by billionaire Eike Batista, dropped 66 percent as short interest rose to 21 percent of float from 11 percent.

Press officials at PDG, OGX and Eletropaulo declined to comment on the short selling.

Short sales have been increasing in part because government policies aimed at reviving the economy are weighing on some of Brazil’s biggest industries, according to Eduardo Guardia, the chief financial officer at BM&FBovespa.

President Dilma Rousseff’s administration has intervened to curb utility rates, bank lending margins, mobile-phone fees and fuel prices -- reducing earnings prospects for sectors with a combined weighting of about 50 percent in the MSCI Brazil index.

Energy, Raw Materials

“The business environment in Brazil is being questioned,” Guardia said in an interview at the Bloomberg office in Sao Paulo on April 18.

The combination of falling commodities prices and rising wage costs is also curbing profits, said Stefan Hofer, an emerging market economist at Bank Julius Baer & Co., which oversees about $215 billion.

MSCI Inc. gauges of Brazilian energy and raw-materials companies, including Rio de Janeiro-based Petroleo Brasileiro SA (PETR4) and Vale SA (VALE5), have tumbled at least 16 percent in local currency terms in the past 12 months as the S&P GSCI Spot Index of commodities slid 8.9 percent.

Brazil increased its minimum wage by 9 percent effective Jan. 1, according to a decree signed by Rousseff. The central bank raised borrowing costs for the first time since July 2011 on April 17 after annual inflation accelerated to 6.59 percent at the end of March, breaching the central bank’s target range.

‘Real Problem’

“The real economy has a real problem with slowing growth and relatively high inflation,” John-Paul Smith, the London- based emerging market strategist at Deutsche Bank AG, who has had an underweight rating on Brazil for the past two years, said in an April 19 phone interview. “It’s very difficult to find stocks you want to buy.”

The 36 percent drop in MSCI Brazil index earnings during the past 12 months is the biggest among equity gauges in 21 emerging markets tracked by Bloomberg and compares with a 3 percent retreat in MSCI Emerging Markets Index profits during the same period.

The Brazil index’s valuation has climbed to about 17 times reported earnings, matching the level in May 2008 when share prices peaked before the global financial crisis. The emerging markets gauge has a multiple of 12, data compiled by Bloomberg show.

Economists surveyed by Brazil’s central bank have reduced their estimate for 2013 gross domestic product growth to 3 percent as of April 19 from an estimated 4.25 percent a year ago. In China, Brazil’s biggest trading partner, GDP growth unexpectedly decelerated to 7.7 percent in the first quarter as factory output weakened.

Fraga’s Optimism

While Brazil’s economy faces challenges, investors have probably turned too bearish, said Fraga, the former central banker and founder of Gavea Investimentos Ltda., with about $7.3 billion under management as of March.

“I don’t think that this is one of those jump out the window type of situations,” Fraga said at an event organized by the Brazilian-American Chamber of Commerce in New York on April 22. He cited voters’ intolerance for a return to high inflation and the country’s growing class of entrepreneurs as reasons to be optimistic.

Analysts are predicting a 24 percent rebound in MSCI Brazil index earnings this year, according to more than 800 estimates compiled by Bloomberg. Based on those projections, the gauge has a forward price-earnings multiple of 11, in line with the emerging market index.

BlackRock’s View

Brazilian stocks “are poised to have a better performance this year and that’s what we’re betting on,” Will Landers, manager of the $4.4 billion BlackRock Latin America Fund, said in an April 23 interview on Bloomberg Television.

It’s too early to call the bottom in earnings, Julius Baer’s Hofer said in an April 18 phone interview from Hong Kong. The same analysts predicting a rebound this year had anticipated 15 percent profit growth a year ago, estimates that missed the mark by about 50 percentage points, data compiled by Bloomberg show.

Retail sales in Brazil declined 0.2 percent in February from a year earlier, the first annual drop since November 2003.

“You’re in the middle of a period of economic difficulty,” said Marketfield’s Shaoul. “There’ll be good news and bad news, but the balance is going to be bad.”

To contact the reporters on this story: Michael Patterson in Hong Kong at mpatterson10@bloomberg.net; Julia Leite in New York at jleite3@bloomberg.net; Ney Hayashi in Sao Paulo at ncruz4@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net

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