2023-06-23 19:13:06
Over the past few months, we have witnessed a veritable roller coaster of emotions in the investment universe, particularly in the Brazilian scenario.
Warren’s Macroeconomic Analysis team was correct in its predictions: the significant improvement in the Brazil risk, given the approval of the fiscal framework and the faster-than-expected deceleration of inflation, keep in mind the beginning of a downward cycle in the Selic from August.
Stocks, real estate funds and even the real once morest the dollar have strengthened, and the Ibovespa has been flirting with our target of 119 thousand points for June 2023.
In this context, few events have been as awaited as the fall in the basic interest rate.
To understand the importance of this moment, it is worth analyzing the history of Selic decline periods and its relationship with the Stock Exchange.
History shows that, on average, the Ibovespa rose 12.4%, 14.3% and 12.7% in the 12 months, 6 months and 3 months before the monetary easing cycles began.
Recently, in May and June, the Brazilian stock market showed clear signs of recovery. As a result, we decided to bring forward our stock exchange valuation review, which normally takes place at the end of each semester.
Here are our new targets for the Ibovespa:
December 2023 – 129K
June 2024 – 134K
December 2024 – 138K
But what causes this movement? Let’s delve into the main factors.
Firstly, high interest rates often hurt stocks.
This happens because the companies spend more on interest on their loans, which reduces net profit.
Many companies stop investing due to higher financing costs.
Os investorsin turn, exchange their shares for fixed income bondswhich become more attractive.
Equity funds begin receiving redemption requests and the individual investor migrates to the CDI, generating a selling flow on the stock exchange. In addition, the present value of companies falls, as discount rates become higher.
In the midst of these considerations, an important point to be discussed is the effectiveness of companies in generating profit in a high interest rate environment.
O Return on Equity (ROE) is a metric that evaluates this ability. Calculated by dividing net income by shareholders’ equity, ROE provides a clear view of how effectively a company generates returns for shareholders.
However, unlike Return on Assets (ROA), ROE does not consider the company’s debt. This means that the more leverage and debt a company takes on, the greater its ROE to ROA.
This is where the DuPont identity comes in, which tells us that ROE is affected by three factors:
A operational efficiency, measured by net margin A efficient use of assetsmeasured by the turnover of total assets A financial leveragemeasured by the equity multiplier.
If interest rates rise, companies’ net margin may fall, and leverage may increase. Both movements put downward pressure on ROE.
The chart below makes a DuPont analysis of the profitability of the IBES Brasil stock index, which contains 216 companies listed on the stock exchange.
The terracotta line in the top panel of the graph shows that since the beginning of the cycle of high interest rates in Brazil, in mid-2021, the net margin of companies (EPS Margin) began to fall sharply, which led to a drop in profitability levels (ROE), illustrated in the bottom panel.
On the other hand, leverage levels have risen and companies’ cost of capital has also risenmaking it less attractive to invest in stocks.
However, when the Selic rate falls, borrowing costs also decrease. Reducing these costs can increase companies’ net margin and improve ROE.
In this way, the drop in interest rates makes stocks more attractive to investors.
It is important to say that this does not happen overnight.
Companies will still have some challenging results ahead of them and there is no guarantee that the stock market will skyrocket because interest rates will start to fall.
For example: if the drop occurs at a slower rate than expected, this might be a negative trigger.
In any case, the stock market tends to react positively to a scenario of interest rate cuts, even if, initially, there may be some volatility.
This positive reaction is not immediate, but begins to be felt over the months following the Selic cut.
And in this context, we believe that the scenario of falling interest rates can bring interesting opportunities for investors who are willing to take a little more risk in exchange for a higher potential return.
But it is worth remembering: it is always important to diversify the investment portfolio and seek a balance between different types of assets, to protect once morest possible adverse scenarios.
And, of course, don’t forget to tailor your choices to your investor profile and your financial goals.
At Warren, we are always analyzing the macroeconomic scenario and the behavior of companies to offer the best investment suggestions.
Every market movement brings with it a range of opportunities that we are ready to help you explore..
Any questions or suggestions are welcome. I answer questions daily on my Instagram (@fredpnobre), and our individual company recommendations, as well as stock and FII portfolios from Warren’s analysis area, are always available to our clients.
We are here to help you navigate these changes and make informed investment choices.
Until the next article!
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