Why is this important for Brazilian investors?

“The Peter Lynch Way of Investing”, by Cash Manager and John Rothschild, is one of many books on investing. However, when I first read the book, I found an element of chapter 17 that surprised me: “the trumpet effect.” In short, Lynch explains that in this article, investors, professionals and amateurs alike, are assailed by recurring reports in the media (mainly in the United States). Most of the time, these messages are not well understood by people, yet they are constantly repeated by everyone (hence the name “drumbeat”). At this point he cites that there is a “trumpet” regarding the issuance of the M1 coin in the United States (this is not the current moment, the book was originally written in 1989). When I first read it, I got the impression that Lynch believed fundraising knowledge was irrelevant to investors.

The reason I was surprised to read this passage is that I think the behavior of M1 is particularly relevant information for investment decisions, especially at present. But what is M1?

According to the Central Bank of Brazil [ii]: “M1 is the amount of paper money and demand deposits held by the public, generated by companies that provide liquidity”. Paper money held by the public is the total amount of currency issued in the form of rupee notes and coins minus the reserves (reserves) of commercial banks and the Central Bank. Demand deposits, also known as “dematerialized currency”, refer to the amount of money in a customer’s current account with a commercial bank (including credit institutions, including Caixa Econômica Federal , commercial banks and certain cooperatives authorized to receive the required deposits). In other words, M1, or “restricted payment”, is the distribution of money in an economy.

In the case of the United States, the definition is similar. According to the Federal Reserve [iii]M1 is a transaction deposit in a public currency and depository companies”, which translates to: M1 is the amount of paper money held by the public with the required deposit in depository societies. The following graph shows the evolution of money supply (M1) in the United States since the beginning of 2018:

M1: dollars (in billions of US dollars)

Source: Own extension based on FRED data [iv] (Federal Reserve Bank of St. Louis)

Looking at the map, you can see an impressive increase in US money supply since April 2020. Covit-19 crisis. In fact, M1 broke through the $20 trillion mark, flooding both goods and services and financial markets with excess cash flow. The effects of the sharp increase in payment mechanisms on inflation of goods and services and on the prices of financial assets have been the subject of intense debate, not only in the United States but around the world, as the Dollar markets were flocking to the funds. From different countries. Picture below (CPI – Consumer price index) Over the past four years:

Swelling

Source: Own extension based on FRED data [v] (Federal Reserve Bank of St. Louis)

Consumer inflation in the United States, as in most global economies (including Brazil), was significantly higher, which worried central banks and the Federal Reserve (FED, the United States, which is debating actively on the monetary policy stance adopted by the central bank) in the light of this context. However, they have not yet entered the elevation cycle, as can be seen in the image below:

Costs

Costs

Source: Own extension based on FRED data [vi] (Federal Reserve Bank of St. Louis)

Despite this, at the last FOMC meeting (Federal Free Market CommitteeOn January 25, 2022, the US Federal Reserve announced that it would begin tapering asset purchase plans from March 2022 and signaled interest rate hikes (Federal financial ratio) By 2022, inflation turns out to be stable (there is a lot of debate in the US about whether current inflation is volatile or stable).

Rising interest rates in the United States have a major impact on the global economy, and rising interest rates could trigger a recurring financial crisis. In 2008, many financial market analysts used the term “Minsky moment”. [vii]A rise in interest rates after a long cycle creates difficulties in meeting previously contemplated debt obligations and could lead to the potential outbreak of a general financial crisis.

Therefore, this moment is very sensitive for US currency officials. On the one hand, inflation has proven to be a valid issue and a concise monetary policy should be adopted. On the other hand, the vast majority of financial assets, especially in the United States, are at their peak at all times and a significant portion of businesses are heavily dependent on debt and credit to run their operations. So, at a time when the global economy is not fully recovering from the gov-19 crisis, rising interest rates have the potential to rattle financial markets.

These decisions have a significant impact on the Brazilian financial market, especially on equities. Although some analysts point out that there has been a positive correlation between US interest rate hikes in the past, such as the 1990s and 2000s, and the rise in Brazilian real estate prices, in general, the rise in interest rates indicates a slowdown in global liquidity. Tends to reduce international capital flows.

However, currently some CFOs in the United States (e.g. Jeremy Granth) [viii]) Financial assets in the United States are overvalued, many of which are the highest ever. On the other hand, they believe that emerging markets have financial assets at very attractive prices. In this way, it is possible for asset managers to seek investment opportunities in markets outside the United States, which could shift significant resources to financial markets in developing countries, especially in the event of sharp decline in US asset prices. . On the other hand, it is important to remember that we are living in a unique moment and past circumstances may not be a good guide for future decisions.

Unfortunately in the financial markets, everything is a question of probability, there is no certainty. In fact, the present moment shows interesting investment opportunities in the stock markets of developing countries, including Brazil. However, the real impact of the cycle of rising interest rates in the United States is not yet known. We do not know exactly what the Federal Reserve’s next steps will be in the face of this change in the central bank’s position or what the economic agents’ response will be. The truth is that the present moment requires serious attention because great opportunities (and risks) present themselves in times of high market pressure.

For this reason, it is essential for investors in risky financial products, both here and in the United States, to know the meaning of money laundering and to monitor their behavior, as well as the debate on inflation and interest rates. of interest.

* Guilherme Ricardo dos Santos Souza and Silva Economist, doctor in economic development and lecturer at the UFPR.

Instagram: guilherme.economista

E-mail: [email protected]

[i] Lynch, Peter; Rothschild, John. Peter Lynch’s way of investing. 2nd ed. Sao Paulo: Penvira, 2019.

[ii] Technical note from the Central Bank of Brazil 48. A methodological study of payment statistics. Brasília, 2018.

[iii] Federal Reserve Board of Governors. Frequently Asked Questions (FAQ)

[iv] Board of Governors of the Federal Reserve System (United States), M1. Federal Reserve Bank of St. Louis.

[v] Organization for Economic Co-operation and Development, Consumer Price Index: Total All Commodities for the United States. FRED, Federal Reserve Bank of Saint-Louis.

[vi] Federal Reserve System (United States), Federal Funds Effective Rate Board of Governors. FRED, Federal Reserve Bank of Saint-Louis.

[vii] The term “Minsky moment” was first used to describe the Russian crisis in 1998, in reference to economist Hyman Minsky and the weak finance hypothesis.

[viii] Calling a Super Bubble: Front Row with Jeremy Grant.

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