May Lead to Short Term Strategic Opportunities for Sugarloaf

Although Brazil was not directly centered in the current global economic crisis the country, like all emerging markets, is surely feeling the effects. This fact is most apparent in Brazil’s stock market (Bovespa) and currency.

After reaching a high of over 70,000 points in May, the Bovespa Index has plummeted since then and now sits around 35,000. The drastic decrease correlates to the U.S. housing market crash over the summer and the global credit crash in the 3Q. Similar to the U.S., Asian and European stock markets, the Bovespa’s tumble has been largely blamed on falling consumer confidence and pessimism of a quick global recovery. Another factor isolated to Brazil has been a decrease in foreign demand of Brazilian exports, especially commodities and raw materials, which were a huge key in Brazil’s emergence this decade.

Also a clear sign that Brazil is not immune to global financial woes has been the tumble of the real over the last few months. Since 2003, the real has strengthened more than 100% against the U.S. dollar and hit its strongest point ever this August at R$1.56 to the dollar. However, as the credit crisis picked up full steam, U.S. and other international firms needing immediate cash began a massive sell-off of reias. The result was a huge increase in demand for U.S. dollars, driving the price of the dollar way up in just a matter of days. Since then the real to dollar exchange rate has fluctuated between R$2.10 and R$2.40, with forecasts predicting it will close out the year around the R$2.10 range.

The good news for Brazil is that economic recovery is expected to come much more swiftly than other countries more directly affected. For one, Brazil’s strict financial regulations prevent local banks and financials from over-leveraging and limit exposure to riskier financial instruments such as mortgage backed securities. Although many Brazilian firms took big hits on currency futures and stepped back on credit, few are at risk of going under.

For Brazil, recovery is most dependent on foreign capital coming back into the market. Although Brazil is a very self-sufficient country, solid economic growth won’t happen without renewed demand in Brazilian commodities as well as local equities. The global long-term outlook on Brazil seems to remain optimistic, however the consensus seems to be that most firms will wait until mid-2009 to re-enter Brazilian markets.

For Sugarloaf Fund, recent economic develops have brought mixed feelings on Brazilian investment. The weakened real has negatively effected Sugarloaf’s capital possessions in terms of U.S. dollars. Also, on the collections side, we may see a slight drop in recovery in the short run.

However, as Sugarloaf prepares to acquire between 3-6 new portfolios in the next several months, the recent economic downturn does bring with it several advantages for The Fund. First, as many Brazilian companies try to navigate the slower economy, their need to increase cash flows may encourage more creditors so sell their distressed assets. We may see an increase in available debt on the market. Along with this, Sugarloaf believes that because many firms have taken a step back from Brazil, the competition for portfolios will be greatly decreased, resulting in lower acquisition costs. Finally, although the currency drop affected our current assets in Brazil, we can now acquire future assets at a discount in terms of U.S. dollars.

With the expected recovery of Bovespa and the real in the next 6-18 months, Sugarloaf could again see capital growth on the currency exchanges much like in the past couple of years.  Based on the current forecasts of Brazil's economy, The Fund is currently positioning itself now as the Brazilian economy begins it's recovery.