from briefing.com:
Just Another Tequila Hangover 11-Jul-01
The equity market got a small taste of the tequila hangover on Tuesday, as some banking stocks came under pressure following rumors that Argentina might cancel a bill auction. Though that rumor proved to be false, the threat from the South is very real. Unlike the 1994/95 tequila hangover, which originated in Mexico, the 2001 version has its roots in Argentina and Brazil. Also unlike 1994/95, this hangover hits at a time of vulnerability for the US economy, and should therefore be watched closely.
Brazilian FX/Energy Wars
Brazil has entered into a dangerous game with the foreign exchange market, trying to contain influences that we would argue are largely beyond its control. The central bank recently announced plans to sell $6 bln in the foreign exchange market to buy Brazilian reals in orderly installments over the rest of the year. In other words, central bank president Arminio Fraga has effectively tossed aside the unwritten rule that the element of surprise is critical when it comes to FX intervention. Of course, it is important to remember that Brazil does not even have a currency problem, it has an energy crisis. A severe drought has exposed the country's overreliance on hydroelectric power, a dynamic that is expected to weigh heavily on industrial production going forward. This should put pressure on the trade account as the country is forced to employ a greater degree of import substitution.
Argentina's Austerity
A bit further South lies another problem: Argentina. Argentina's recent debt swap and shift to a dual exchange rate mechanism has led to more talk of both default and outright peso devaluation. However, Briefing.com is also concerned by the recent announcement that public spending will be cut yet again. While the ultimate purpose of the cut is to bolster investor confidence in Argentina, we believe that the government's priorities should be focused on stimulating demand. In other words, achieving arbitrary IMF targets means very little if the government cannot dampen an internal confidence crisis. A continued festering of this crisis will only lead to further economic weakness as workers launch strikes in protest of fiscal austerity. Of course, such tensions will also foster a heightened sense of political insecurity, as the opposition is likely to sympathize with the public in an effort to return to power.
Roadblocks To Recovery
The equity market has already been guilty of complacency regarding European and Asian economies, whose weakness is now hitting US corporate earnings. Before unwarranted complacency sets in again, we would note that Latin America is an influential source for US global earnings.
During the 1990s, Brazil ranked sixth in terms of US foreign affiliate income (which is considered by the BEA to be an excellent proxy for US global earnings), with Mexico right behind it, ahead of the likes of Japan, Australia and France. During the first quarter of 2001, the latest data from the BEA shows that foreign affiliate income in South America fell roughly 5%, thanks almost entirely to a 50% year on year plunge in Argentina. While not included in the South American component, a similar trend was evident in Mexico. Foreign affiliate income in Mexico surged 36% year/year in Q1, but was down nearly 2% sequentially from Q4.
In other words, weakness in Latin America is already helping to exacerbate the profits recession here at home. This drag is likely to intensify as Argentina remains in dire straits. In addition, a lethal combination of currency weakness, overly tight monetary policy and energy rationing is expected to put more pressure on Brazil. Finally, we would note that the process of globalization has left Mexico vulnerable to US weakness, as will most likely be evidenced by a fourth consecutive monthly decline in Mexican industrial production data to be released on Thursday. While the Mexican consumer has held up fairly well, we would note that the pullback in production has led to sharp declines in maquiladora employment, suggesting that consumer retrenchment may be on the way.
Now that investors have finally acknowledged the seriousness of the slowdown in Europe and Asia, they risk missing another global story. The Argentine Merval index was down 6% on Tuesday and over 20% in just the past month - US investors should stay alert to further deterioration in Latin America, as the hangover might yet hit home.
Dan Antonellis - dantonellis@briefing.com |
