Invest in Brazil

Invest in Brazil: The Hazards of Familiarity
by Eric J.  Fry
The Rude Awakening
Wall Street, New York
Thursday, December 8, 2005

Eric Fry explains why, given a choice between investing in GM or Brazil, you should Invest in Brazil.

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[Joel's Note: Below, Eric pits junky GM bonds against the
emerging market of Brazil. Aside from boasting the world's
skimpiest bikinis, Brazil also finds itself in possession
of a fairly robust economy...at least one growing TOWARDS
robust anyway.

Before you read on, however, you might want to take a look
at the investment alert sent out late yesterday afternoon.
Addison Wiggin, our publisher, has recently announced the
reopening of the Agora Financial Reserve doors. The price
on this select, lifetime service is going to shoot up on
Jan 1 and there is bound to be a holiday rush before then.
You would do well to check it out here before the stampede.

http://www.agora-inc.com/reports/AFR/EAFRFC02

As always, you can email any comments, complaints,
suggestions or anything else Rude related to me here at
aussiejoel@the-rude-awakening.com

Now, back to those Brazilian bikinis... I mean bonds...

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The Hazards of Familiarity
By Eric J. Fry

Familiarity breeds contempt...but not right away. In the
beginning, familiarity breeds desire, when then becomes
mere comfort, then only tolerance, then resignation...and
THEN contempt.

Most U.S. bond investors appear to have entered the
comfort/tolerance phase. We predict they will arrive at the
contempt phase...eventually. But for now, most bond
investors prefer familiar, high-risk bonds to unfamiliar,
lower-risk bonds.

As recently as last February, for example, bond buyers
readily accepted a 5.6% yield on the 3-year paper of
General Motors. We were amazed. In the February 11 edition
of the Rude Awakening we observed, "GM's debt load is
massive and growing. Its net debt outstanding has doubled
over the last four years to $244 billion. In addition, GM's
balance sheet contains a towering pension liability of
$102.4 billion and a $67.5 billion liability for other
post-employment benefits (OPEB), primarily health care,
insurance and other benefits that the company is committed
to providing both current retires and active employees.
These already-considerable costs seem certain to
grow...Net-net, GM seems fully deserving of its 'near junk'
rating and seems likely to trend from bad to worse."

In other words, GM's tenuous financial health was no secret
last February. And yet, investors continued to bid for GM
bonds, even after the company fell into the ranks of junk
credits. (To be sure, the buyers of GM bonds have been
demanding ever higher rates of interest over the last
several months. But they still buy, nonetheless).
Meanwhile, the Brazilian government's 3-year notes have
gone begging. Unfamiliarity, tinged with suspicion, is to
blame.

Invest in Brazil: "Brazil is not GM"

"Brazil is not GM," some might protest. To which we would
reply, "Thank goodness." Brazil, despite its considerable
foibles, runs a trade surplus and only a very slight
government deficit. It also boasts the world's strongest
currency over the last three years. GM, for its part, is
merely familiar. The teetering auto giant has managed to
attract buyers to its bonds, based on what it has
been...NOT on what it threatens to become.

Throughout the last year, the Rude Awakening has
continuously spurned GM's stock and bonds, while
simultaneously extolling the virtues of certain Brazilian
investments. We have not been blind to either GM's storied
past, nor to Brazil's checked economic history. But we
simply believed that the relative pricing of GM and
Brazilian bonds was way out of whack. We still do, though
less out of whack than 10 months ago.

On March 25, for example, Brazilian 3-year notes paid an
18.1% rate of interest, while GM 3-years paid only 6.5%.
Today, Brazilian 3-years yield a still-hefty 16.5%, while
GM 3-years yield a nearly identical 16.2%.

Which one is the better credit; the fatally-indebted auto
giant or the resurgent South American economy?

The question answers itself...GM is skidding toward
bankruptcy, while Brazil is lurching toward financial
respectability.

Until recently, however, General Motors' lengthy history of
success – it was the first American corporation to earn $1
billion in one year, for example – protected it from
exacting credit analysis. Bond-buyers turned a blind eye to
its questionable health and blithely assumed that GM's past
would faintly resemble its future. On the flip-side, bond
investors have shunned Brazilian debt. The country's
considerable recent successes have not yet erased its
legacy of serial currency and debt crises. So even if the
country's resource-based economy is flourishing for the
moment, the memory of catastrophic failure is too fresh to
encourage bond-buying.

Invest in Brazil: Familiarity Becomes Contempt

But we suspect that the world is changing, and that we may
no longer trust assumptions from the past to guide
investments in the future. For your editors here at the
Rude Awakening, GM's familiarity has already reached the
contempt phase...We would not wish the automaker's bonds on
the North Koreans.

Indeed, generally speaking, we would spurn all US high-
yield debt in favor of foreign sovereign debt. Both are
risky; but we would prefer the risk of holding bonds from
unfamiliar, but increasingly credit-worthy, foreign
governments to the risk of holding familiar U.S. junk
bonds.

"When the Banana Republic countries can borrow at single-
digit interest rates, it means investors have no fear,"
Steve Sjuggerud recently observed. "Right now, the lack of
fear in emerging markets (based on emerging market interest
rates compared to U.S. interest rates) is literally off the
charts.

"As a group right now, emerging market countries can borrow
for the long term at an average interest rate of 6.8%. 
This is ludicrous, and a record low level.  2.4 percentage
points above U.S. Treasury interest rates is the record,
and it's where we are now.

"Why's this so important? Only twice in history have
emerging market countries ever been able to borrow at less
than 4 percentage points above U.S. Treasury interest
rates... early 1994 and mid-1997. Immediately following
both of those cases, stocks in emerging markets were
absolutely obliterated. 

"An average investor in those markets ('94 and '97-'98)
probably lost over half their money in both instances. 
Here we are again, where emerging market countries can
borrow at 4 percentage points over Treasury rates or less."

Invest in Brazil: Double Sell

We would not quarrel with Dr. Sjuggerud's observation, but
we would add two qualifications. 1) The narrowing of
spreads between Treasurys and emerging market debt may be
saying as much about the deteriorating credit-quality of
the U.S. government as it does about the improving credit-
quality of emerging markets. But that's a topic for another
day; 2) If emerging market bonds are a sell, U.S. junk
bonds are a "double sell."

Just as Brazilian 3-years represent a more compelling
opportunity than GM 3-years, so too, we believe, do
emerging market government bonds offer a better opportunity
than U.S. junk bonds.

To frame the comparison, let's consider two NYSE-traded
closed end funds: the Salomon Brothers Emerging Market
Income Fund II (NYSE: EDF) and the RMK High Income Fund
(NYSE: RMH).

RMH holds BB-rated (junk) bonds from US issuers; EDF holds
BB+-rated government bonds from emerging markets. RMK pays
10% per annum; EDF pays 8%. (most of the difference in
yields results from the fact that RMH applies more leverage
to its portfolio than EDF.) On the surface, therefore, both
investments seem roughly comparable. But if we dig a little
deeper, key fundamental differences emerge.

RMH's top ten holdings include the junk-rated bonds of
airline-leasing companies, mortgage-lenders and
manufactured-home financers. By contrast, Brazilian
government bonds represent 22% of EDF's portfolio, while
Mexican bonds represent 21%.

No doubt, RMH and EDF both hold risky bonds. But we'd
rather buy into the unfamiliar risk of growing foreign
economies than the familiar risk of troubled U.S.
industries.

In short, familiarity is overpriced.

[Joel's Note: If your investments are begging for a
vacation, maybe somewhere warm and away from the blistering
cold of Wall Street, you could well benefit from the
insight of the worlds greatest living economist, Dr.
Richebacher. See what the good Doctor has to say right
here:

The Richebacher Letter
www.agora-inc.com/reports/RCH/ERCHFB05/ 

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