Investing in emerging markets
UBS CIO Wealth Management Research
5 June 2014
World Cup 2014 in Brazil
ab
Publication details
Publisher
UBS Financial Services Inc.
1285 Avenue of the Americas
New York, NY 10019
This report has been prepared by UBS Financial
Services Inc. (“UBS FS”).
Please see important disclaimers and
disclosures on page 16. Past performance
is no indication of future performance. The
market prices provided are closing prices on
the respective principal stock exchange. This
applies to all performance charts and tables in
this publication.
Authors
Andreas Hoefert, Chief Economist and
Regional CIO Europe
Jorge O. Mariscal, Regional CIO Emerging Markets
Alejo Czerwonko, analyst
Desktop Publishing
Virender Negi*
Basavaraj Gudihal*
Cover Picture
Getty Images
* Employees of Cognizant Group.
Cognizant staff provide research support
services to UBS.
Contents
World Cup 2014 in Brazil
01
03
06
12 Introduction Brazil faces momentous World Cup pressure
Section 1 What does the World Cup mean for Brazil’s
economy and markets?
Section 2 What does the World Cup mean for Brazil’s
standing in the developing world?
Section 3 And the World Champion is…
Introduction
Brazil faces momentous
World Cup pressure
Jorge O. Mariscal, Regional CIO Emerging Markets, UBS FS
[email protected]
Andreas Hoefert, Chief Economist and Regional CIO Europe, UBS FS
[email protected]
Normally, investors rightly dismiss football World
Cups as having negligible economic or market significance. They should treat the 2014 tournament
in football-mad Brazil as an exception. According
to our forecasting models (see the final section of
this report), Brazil is the clear favorite to win. But
it has also spent so much on the World Cup, and
lagged so severely in other economic and financial
areas, that organizational or footballing failures
during the World Cup could cause significant popular discontent. With highly-contested presidential
elections coming up in October, investors should
not underestimate the World Cup’s impact on
Brazil’s political future, and what that means for
its economy and markets.
There are two reasons for this.
1. Popular support for the Cup is unprecedentedly
low for a country like Brazil, where footballing
passion runs deep. The latter underscores the
heightened level of frustration of large segments of society with poor infrastructure, lack
of public safety, high levels of corruption, and
an over-reaching government.
2. If the World Cup is a failure, short-term socioeconomic sentiment will be bleak. This could
spell the end for incumbent president Dilma
Rousseff, who is struggling to gather enough
votes for reelection.
In the streets of Rio de Janeiro last week, demonstrators carried a banner saying: “A school
teacher is worth more than Neymar.” Neymar
da Silva, a gifted forward in the national team,
was transferred last year from local club Santos
to Barcelona in Spain for a reported fee of EUR86
million. This disconnect between the economics
of soccer and the mood on the streets is putting
mounting pressure on the national team’s, as well
as the organizers’, performance. Failure on either
front could ultimately shatter Rousseff’s hopes
for re-election.
Paradoxically, however, short-term economic pain
and anti-Dilma sentiment could be good for financial markets. Brazilian stocks have rallied in recent
months as prospects for more market-friendly
candidates have increased while hopes for Dilma
have declined. With that in mind, investors should
be open to the possibility that World Cup disappointments may put upward pressure on Brazilian
markets and vice versa.
When analyzing the World Cup, investors should
watch three key variables: football, infrastructure,
and the streets. The probability of a breakdown
in infrastructure or in the social order is hard to
quantify in advance. But when it comes to World
Cup results, some statistical factors do have predictive power.
1. The so-called Elo rating, an objective measure
of the strength of each team before the World
Cup;
2.Past World Cup performance;
3.Which team hosts.
World Cup 2014 in Brazil
5 June 2014
1
Introduction
Brazil scores high on all three. In particular, not only
is Brazil hosting, but it will go into the World Cup
with a higher Elo rating than any team in history.
Investors should also be mindful of the dangers,
however. With the exception of Germany in 1974,
no team entering the World Cup with the highest
Elo rating has ever won the competition. Moreover,
popular support for the tournament has been fading. According to Datafolha, a polling institute,
just 48% of Brazilians are currently in favor of
hosting the event, down from a high of 79% in
November 2008. Many Brazilians appear to feel
that, instead of spending an estimated USD 14
billion on the World Cup, their country could have
put the money to better use.
Based on historical evidence from other countries,
investors should expect World Cups to have little
meaningful economic or financial market impact,
2
5 June 2014 World Cup 2014 in Brazil
either on the winning or hosting country. However,
given the particular political juncture Brazil is facing and an already unstable social situation, they
should anticipate a more sizable impact from this
World Cup than normal. If the existing infrastructure proves insufficient or protests cause severe
disruption, this may further sour global investors’
negative sentiment towards Brazil or even emerging
markets, in general. If Brazil fails to win the Cup,
the mood on the streets could get much worse.
In sum, investors should see unrest in Brazil as a
possible positive for markets – that is, if it means a
more market-friendly candidate beats Dilma in the
elections. However, they should also not entirely
discount a scenario whereby overall disillusionment
with the country intensifies. Investors should bear
in mind that curing Brazil’s structural ailments is
likely to involve a period of bitter medicine – no
matter who wins on the field or at the ballot box.
Section 1
What does the World Cup
mean for Brazil’s economy
and markets?
Jorge O. Mariscal, Regional CIO Emerging Markets, UBS FS
[email protected]
Alejo Czerwonko, analyst, UBS FS
[email protected]
For most national economies, football is just a
sport – a marginal contributor to growth and
employment, and a negligible influence on politics
and markets. For a football-mad country that has
spent controversial sums hosting a World Cup just
months before a national election, the “beautiful
game” has greater material significance. In the
case of the 2014 “copa do mundo” in Brazil, the
host nation has experienced economic, political,
and market strain that has no precedent in World
Cup history.
The performance of “a Seleção,” the national
football team, together with the tournament’s
organizational success, could leave a lasting mark
on Brazil. If “a Seleção” wins and the tournament
runs smoothly, the current president of Brazil, Dilma
Rousseff, will likely benefit from a sentiment boost
that would support her quest for reelection. On
the other hand, if the national team puts in a
shameful performance or the tournament suffers
a major organizational setback, this will lead to
widespread discontent that could easily tilt the
balance of power towards the opposition in the
electoral race. These two outcomes imply largely
different paths for the Brazilian economy and the
prices of local financial assets.
To understand why the World Cup might affect
Brazilian politics, economic activity and markets,
we need to recognize that soccer is an important
driver of sentiment in the country. Brazil has close to
30,000 football clubs, two million registered players
and about 5,000 professional games every year.
Flamengo, a Rio de Janeiro-based team, flaunts a
fan base of 32 million people, more than any other
soccer club in the world, and almost double the
New York Yankees’ 17 million fans. While some
believe football is a matter of life and death, for
Brazilians the game is much more important.
But despite this, local support for the tournament
has been fading. According to Datafolha, a polling institute, just 48% of Brazilians are in favor of
the country hosting the event, down from a high
of 79% in November 2008. The street buzz that
would normally precede the “copa das copas” –
the adorning of cars with flags and banners, the
painting of walls and streets – has been muted.
Why is “o País do Futebol” disenchanted with
hosting its favorite tournament? Because its growing middle class most likely feels that, instead
of spending an estimated USD 14 billion on the
World Cup, Brazil could have put the money to
much better use.
The Brookings Institution estimates that, in the last
decade, some 38 million Brazilians have joined the
ranks of the middle class – defined as individuals
spending USD 10–100 per day in 2005 purchasing
power parity terms. While 32% of the Brazilian
population belonged to this category ten years
ago, the number has spiked up to 48%. As this
middle class has grown, so have its expectations
with respect to public goods and services. The
World Cup 2014 in Brazil
5 June 2014
3
Section 1
authorities have failed to match these expectations themselves or incentivize the private sector
to offer sufficient alternatives.
Earlier this year, middle-income groups staged protests in the country’s major cities, with demands
ranging from better transport infrastructure and
less corruption to improved security. It is hard to
blame them. On the infrastructure front, airports,
roads, railways, and ports all need expansion and
modernization. On a normal day, a trip from downtown São Paulo to Guarulhos airport can take
2.5 hours. The 260-mile drive from São Paulo
to Rio de Janeiro can easily take six hours, and
no passenger train service currently connects the
two cities. A high-speed rail link that was due to
be operational by 2014 has seen its completion
date pushed out at least six years. It is little wonder that, according to the 2014 global competitiveness report published by the World Economic
Forum, the country ranks below Iran in terms of
the quality of its infrastructure (see Fig. 1.1). The
source of these deficiencies can be partially traced
to the so-called “custo Brasil,” or the high cost of
doing business due to asphyxiating levels of red
tape. According to the World Economic Forum,
Brazil has the second worst regulatory burden in
the world, surpassed only by Venezuela.
Beyond that, the organization of the World Cup
has also been stained by a series of fatal construction accidents. Last November, a 500-ton crane
collapsed on top of the São Paulo Arena, killing
two workers and clipping part of the roof of the
venue expected to host the opening match on
June 12. International concern over the event’s
organizational hindrances is mounting.
Against this backdrop, if the national team “crashes
and burns” in the Cup, or if the tournament suffers a major organizational catastrophe – such as a
stadium collapse or a fatal security breach – widespread social discontent could ensue. Brazilians’
focus would shift away from soccer towards reassessing why so much money has been spent on a
cause of national humiliation. Dilma Rousseff and
her political party, the Partido dos Trabalhadores
(PT), would likely “foot the political bill” of a World
Cup failure, particularly as the organization of the
tournament was a PT construct which began under
former president Lula da Silva’s term.
4
5 June 2014 World Cup 2014 in Brazil
The effect on markets might not be as gloomy,
however. Paradoxically, investors would likely interpret short-term bad news for Brazil and the PT as
good news for the long-term future of the country.
The value of Brazilian assets would likely rally as
the market begins to price in a larger probability of
victory by a more market-friendly opposition party.
Market reaction would likely resemble that
observed since mid-March, when opinion polls
began to show that President Dilma Rousseff’s
triumph in the presidential elections this coming
October was less of a foregone conclusion than
expected. According to the Brazilian Institute of
Public Opinion and Statistics, Dilma’s approval
rating fell to 34% from 43% in December, very
close to the 30% level considered critical for an
incumbent to win a second term. Concurrently,
the MSCI Brazil equity index outperformed the
MSCI index of emerging market equities and significantly outpaced the returns delivered by the
S&P 500 index (see Fig. 1.2).
On the flip side, if Brazil wins the Cup with no
major organizational hitch, locals will celebrate.
Dilma Rousseff and the PT party would take
credit for the success and likely benefit from the
Fig. 1.1: World Economic Forum’s Global Competitiveness
Report Rankings (2014)
Burden of government
regulation ranking
(total of 148 nations, 1 = best)
Infrastructure ranking
(total of 148 nations, 1 = best)
Ukraine
137
Namibia
60
Algeria
138
Indonesia
61
Slovak Republic
139
Kazakhstan
62
Hungary
140
Puerto Rico
63
Argentina
141
Mexico
64
Serbia
142
Iran
65
Croatia
143
South Africa
66
Greece
144
Slovak Republic
67
Kuwait
145
Ukraine
68
Italy
146
Azerbaijan
69
Brazil
147
Montenegro
70
Venezuela
148
Brazil
71
Source: UBS, World Economic Forum
What does the World Cup mean for Brazil’s economy and markets?
improved social sentiment. Low unemployment,
the PT party’s substantial air time on TV, and Latin
America’s strong incumbency bias would also support Dilma’s re-election.
However, what is good for the incumbent is not
necessarily good in the long term for Brazil’s economy and markets. Market consensus foresees no
major reform proposals during Dilma’s second
term, while the old policy mix of price controls,
directed government spending and subsidized
credit is expected to stay in place. Brazilian asset
prices would likely underperform other emerging
markets in this scenario.
Even in the event of a World Cup triumph, Dilma
still needs to watch out for another player that
could spoil her party. Droughts are putting severe
stress on Brazil’s hydroelectric system, which is critical for its power supply. Current data suggests that
water reservoir levels in the south-eastern region
of Brazil are close to lows last seen in 2001, when
energy rationing occurred (see Fig. 1.3). A repeat
scenario may not be a question of if, but when.
The current administration will try to avoid rationing before the October elections. (In 2001, rationing helped the opposition to victory.) But the
longer the decision is postponed, the larger the
economic consequences will be. As a result of the
use of thermal energy, higher spot energy prices
may also impact consumer price inflation. This
is expected to creep up to the top of the central
bank’s target by year-end, despite the fact that
the bank has raised its policy rate a total of 375
basis points since April 2013. Higher inflation could
easily lead to greater social discontent.
In sum, no other World Cup tournament in history has been so intertwined with the political and
economic future of a country. It is for this reason
that investors should get ready to carefully follow
developments not only inside the soccer stadium,
but also on the streets of Brazil’s largest cities.
Fig. 1.3: Electricity risk: water reservoir levels in South and
Southeastern regions
In %
Fig 1.2: Equity market performance in Brazil and Dilma’s
approval rating
120
45
110
40
100
35
90
30
25
80
Dec-13
Jan-14
Feb-14
Dilma’s approval rating (rhs)
MSCI Brazil Index (15 Dec 2013 = 100)
Source: UBS, Bloomberg
Mar-14
Apr-14
May-14
Critical govt approval level (rhs)
90
80
70
60
50
40%
40
30
20
10
0
Jan
Feb
37%
35%
Mar
Apr
May
Jun
Jul
Aug
Sep
2013
2014
Average level since 1998
2001 (Rationing year)
Oct
Nov
Dec
Source: UBS, Operador Nacional do Sistema Elétrico – Brazil
World Cup 2014 in Brazil
5 June 2014
5
Section 2
What does the World Cup
mean for Brazil’s standing in
the developing world?
Jorge O. Mariscal, Regional CIO Emerging Markets, UBS FS
[email protected]
Along with China, Brazil is one of the developing world’s two largest economies and, along
with Argentina, one of its two finest footballing
nations. There, however, the parallels between
Brazil’s footballing dominance and its financial
or economic standing must end. As explained in
the previous section, there is a large gap between
Brazil’s sporting investment in the World Cup and
its recent socioeconomic and market performance.
As a result, World Cup-related discontent has risen
in Brazil. In recent months, this disconnect between
football fever and economic or financial market
impact has affected Brazil more than any historical
correlations between the two sets of variables.
Brazil: A football superpower with a
‘fragile five’ economy
Among emerging economies, Brazil has the most
accomplished footballing track record. It has lifted
the World Cup five times, in 1958, 1962, 1970,
1994, and 2002. Within the developing world, only
Argentina and Uruguay come close. Argentina has
won the tournament twice, in 1978 and 1986.
Uruguay won the first-ever World Cup in 1930 and
then again in 1950, defeating Brazil at home in
the Maracana stadium in Rio de Janeiro. Memories
of the “Maracanazo” still haunt Brazilian soccer
fans old enough to remember.
There are also good odds that the Brazilian team
could face its regional soccer nemesis Argentina
in the final. The rivalry between Argentina and
Brazil is legendary. Brazil has won more World
Cups than Argentina, but the latter has won as
6
5 June 2014 World Cup 2014 in Brazil
many major international competitions. And, out
of 95 matches played between the two national
teams since 1914, Argentina has won 36 times and
Brazil 35 times, with 24 draws. Brazil’s national
team has two related objectives:
1.to win the Cup
2.not to lose to Argentina
National rivalries aside, Argentina and Brazil remain
prolific factories of footballing talent, capturing
20% of a player export market worth an estimated $2 billion last year. In the first half of 2013,
Argentina’s exports of soccer players totaled $228
million, exceeding Brazil’s $182 million, according
to Euroamerica Sports Marketing. But that is at
least partially a reflection of the stronger domestic
demand for soccer players in Brazil.
This Latin American strength is not confined to
Argentina and Brazil alone. In the developing
world, Latin America is the strongest region for
football overall. FIFA rankings for the four best Latin
American teams – Brazil (4), Colombia (5), Uruguay
(6), and Argentina (7) – place them among the top
seven globally, below Spain (1), Germany (2), and
Portugal (3). In addition, Chile (13), Mexico (19),
Ecuador (28), Honduras (30), and Costa Rica (34)
are also in World Cup, so Latin America is likely
to perform strongly.
Economically speaking, however, the picture is
different. Despite its size (its $2.2 trillion economy
is the second largest in the developing world,
What does the World Cup mean for Brazil’s standing in the developing world?
after China) and considerable industrial breadth,
Brazil has been lumped together with the “fragile
five” emerging markets, with large twin current
account and fiscal deficits which make them vulnerable to external economic shocks. The other
economies in this category are India, Indonesia,
South Africa, and Turkey.
However, Brazil’s economic weakness does not
seem to have an impact on its soccer prowess. In
fact, Brazil is the only country among the “fragile
five” to be in this year’s World Cup.
• Turkey did not qualify for the World Cup this
year, but participated in two previous World
Cups, in 1954 and in 2002. On the first occasion, Turkey came in 9th overall. In 2002, it
surprised the world by coming in 3rd place,
losing only to Brazil in the semi-finals. Today
its FIFA rank is 39.
• South Africa hosted the World Cup in 2010,
which gave it an automatic pass into the tournament. It also participated in 1998 and 2002, but
has always been eliminated in the first round.
It is now ranked 65 by FIFA.
• Indonesia (152) has participated in the World
Cup only once in 1938, when it was still known
as the “Dutch East Indies.” On that occasion, it
did not get past the group phase of the tournament and placed 15th overall.
• India (147) has never participated in the World
Cup. Though it qualified in 1950, the India
national team withdrew from the games, reportedly lacking the funds to pay for the players’
long trip to Brazil.
• per-capita GDP
• population
• the World Bank’s “ease of doing business”
rankings.
As per these figures, Brazil ranks first among the
top 50 emerging market soccer teams but ranks
in the lower half for all other indicators, except
its number one ranking for population (China,
India and Indonesia do not feature in the football
top 50) and per-capita income, where it ranks
15. It languishes in the bottom third for growth
(36), inflation (36), and for ease of doing business
(29). Argentina, the other emerging market soccer
powerhouse, ranks near the bottom on inflation
(41) and, even worse than Brazil, on the “ease of
doing business” indicator (32).
In Fig. 2.2, we show the extent that FIFA rankings for the top 50 emerging market teams are
correlated with each of the different variables.
The findings confirm the suspicion: there is no
discernable correlation between the rankings and
economic variables, such as budget and current
account deficits, inflation, economic growth or
even ease of doing business. There is only a low,
but positive, correlation between soccer and population size (30%) and per-capita income (16%).
These two variables may have a positive influence
on the economics of local soccer leagues, their
competitiveness, and advertising revenues. These
may ultimately result in better salaries for players
and a greater ability to attract international stars,
which may raise a country’s playing level over time.
World Cup prospects are not linked to
emerging economic success
If readers have noticed that there is no apparent
relationship between a country’s football skill and
its economic success, then they are on to something. (Contrast this with club football, where
the owners’ largesse has more of a bearing.) In
Fig. 2.1, we show the top 50 football rankings
for emerging market nations alongside several
corresponding rankings according to economic
and social variables, including:
Footballing/economic disconnect
matters for Brazil
If economic conditions have little or no bearing
on soccer results, the opposite must be true: the
outcome of the World Cup matters little for the
economies with the winning teams and even less
for other emerging economies in the tournament.
For hosting nations, the World Cup has benefits
and costs. The buildup of necessary infrastructure
is expensive and disruptive but, in exchange, the
hosting nations get to bathe in the global limelight
and harvest tourism and broadcasting revenues.
• the past three years’ average economic growth
and inflation
• last year’s budget and current account deficits as
a percentage of Gross Domestic Product (GDP)
As discussed in the previous section, however,
Brazil may be an exception. The country will host
the games in the middle of a highly competitive
campaign leading up to the presidential elections (text continued on page 10)
World Cup 2014 in Brazil
5 June 2014
7
Section 2
Fig. 2.1: Top 50 emerging markets by FIFA ranking and their economic characteristics
May 2014
FIFA ranking
2011–2013
average real
GDP growth (%)
2011–2013
average
inflation (%)
2013 fiscal
balance as
% GDP
2013 current
account balance
as % GDP
2013 GDP per
capita (USD)
Brazil
1
36
36
29
28
Colombia
2
15
15
11
25
Uruguay
3
18
40
18
Argentina
4
17
41
Greece
5
50
1
Chile
6
13
Ukraine
7
Russia
Mexico
2013 population
(millions)
2014 ease of
doing business
rank
14
1
29
21
10
8
35
6
46
21
30
17
13
12
32
25
15
4
29
19
19
9
27
7
23
4
38
20
36
43
35
11
28
8
27
34
12
12
8
3
24
9
28
16
31
21
18
4
12
Croatia
10
48
6
42
13
9
43
22
Côte d'Ivoire
11
21
4
22
19
45
20
44
Egypt
12
35
44
49
23
37
5
34
Bosnia and Herzegovina
13
46
11
16
33
32
44
35
Algeria
13
29
28
8
16
28
14
40
Ecuador
15
10
31
32
20
26
26
36
Serbia
16
44
38
44
32
27
36
25
Honduras
16
25
32
47
41
40
34
33
Romania
18
34
12
24
18
20
22
20
Armenia
19
16
22
23
40
38
47
5
Costa Rica
20
20
23
43
31
19
42
26
Panama
21
3
35
27
46
16
45
14
Islamic Republic of Iran
22
49
48
10
4
30
6
39
Ghana
23
4
39
48
47
42
19
17
Turkey
24
14
43
13
38
17
7
18
Venezuela
25
23
50
50
9
12
18
48
Peru
26
9
24
6
30
24
15
7
Nigeria
27
7
42
38
6
43
2
38
Hungary
28
45
17
20
8
10
32
13
Tunisia
29
41
18
45
39
33
31
11
Cameroon
30
19
8
34
29
44
21
45
Guinea
31
24
47
40
50
50
28
46
Uzbekistan
32
5
45
4
11
41
16
na
Montenegro
33
42
10
21
49
23
50
9
Korea Republic
34
30
7
5
5
3
9
1
Paraguay
34
12
25
14
14
34
37
27
Mali
36
40
30
26
26
49
24
42
Burkina Faso
37
6
27
28
37
48
25
41
Libya
38
2
49
3
24
15
40
49
Senegal
39
26
9
41
44
46
27
47
Jordan
40
31
13
39
45
29
38
31
South Africa
41
33
33
35
34
25
8
6
United Arab Emirates
42
22
2
1
2
1
33
2
Bolivia
43
11
37
7
7
39
30
43
El Salvador
44
37
26
33
36
36
39
30
Albania
45
39
3
46
42
31
48
23
Sierra Leone
46
1
46
17
48
47
41
37
Poland
47
32
21
37
22
11
13
10
Bulgaria
48
43
5
15
10
22
35
15
Trinidad and Tobago
49
47
29
19
3
5
49
16
Saudi Arabia
50
8
14
2
1
2
17
–11%
–4%
16%
Country
Correlation vs. FIFA ranking
–7%
Source: International Monetary Fund (IMF), World Economic Forum, FIFA.com
8
5 June 2014 World Cup 2014 in Brazil
–7%
30%
3
–2%
What does the World Cup mean for Brazil’s standing in the developing world?
Fig. 2.2: Correlation between emerging market FIFA soccer rankings and economic variables
2011–2013 Avg. GDP growth
2011–2013 Avg. inflation
60
60
Correlation: –7%
50
50
40
40
30
30
20
20
10
10
0
0
10
20
30
40
50
60
0
Correlation: –7%
0
10
20
May 2014 FIFA ranking
2013 fiscal balance/GDP
60
Correlation: –11%
50
50
40
40
30
30
20
20
10
10
0
10
20
30
40
50
60
0
10
20
30
40
50
60
2013 population
60
60
Correlation: 16%
50
50
40
40
30
30
20
20
10
10
10
60
May 2014 FIFA ranking
2013 GDP per capita
0
50
Correlation: –4%
May 2014 FIFA ranking
0
40
2013 current account balance/GDP
60
0
30
May 2014 FIFA ranking
20
30
40
50
60
May 2014 FIFA ranking
0
Correlation: 30%
0
10
20
30
40
50
60
May 2014 FIFA ranking
2014 ease of doing business ranking
60
Correlation: –2%
50
40
30
20
10
0
0
10
20
30
40
50
60
May 2014 FIFA ranking
Source: IMF, World Economic Forum, FIFA.com
World Cup 2014 in Brazil
5 June 2014
9
Section 2
in October. Groups opposing the administration
are already using the “display window” offered by
the event to capitalize on the frustration of large
segments of the population with poor infrastructure, high levels of insecurity, corruption, and an
over-reaching government. In the streets of Rio
de Janeiro in the last week of May, demonstrators
carried a banner saying: “A school teacher is worth
more than Neymar.” Neymar da Silva, a gifted forward in the national team, was transferred earlier
this year from local club Santos to Barcelona in
Spain for a reported fee of EUR86 million. Failure
of the Brazilian national team to reach the finals
is likely to spark further resentment.
In terms of Brazil’s standing among other “fragile five” economies, this footballing dynamic is a
unique swing factor. As mentioned, none of the
other “fragile five” nations stand to gain or lose
anything from this World Cup. Failure in the World
Cup, however, could dent short-term economic
sentiment in Brazil relative to its fellow “fragile
five” nations.
Footballing/market disconnect matters
as well
What about the impact of winning the Cup on
financial assets? In Fig. 2.3, we look at the performance of winning nations’ stock markets in
local currency terms since the 1974 World Cup.
In six out of eight incidences, the winner actually underperformed global equities (MSCI World
Index) in the week after the final, with a median
underperformance of –0.7%. When we look at
one-month performance after the World Cup, the
median nation outperformed by +0.7%. Two outliers stand out: the 1994 and 2002 World Cups,
both of which were won by Brazil.
In 1994, Brazil’s Bovespa index significantly outperformed. The country enacted a significant
monetary reform, the Plano Real, to stabilize the
economy during the month the World Cup final
was held, which led to the introduction of the
modern Brazilian real. Fernando Henrique Cardoso,
the Minister of Finance, was elected president
that year after helping to bring inflation under
control. As a result, one must attribute the 1994
outperformance to positive economic and political developments, rather than the outcome of
the World Cup.
10
5 June 2014 World Cup 2014 in Brazil
In 2002, financial markets panicked over the prospect of left-winger Luiz Inacio Lula da Silva (Lula)
from the PT Party winning October’s presidential
elections. The Brazilian real weakened 40% in the
first six months of 2002 leading into the World
Cup final in June. Despite Brazil’s 5th World Cup
victory, the stock market declined in the three
months that followed. In this case, the market’s
fear of unorthodox economic policy from Lula
overwhelmed the World Cup sentiment, and the
Bovespa underperformed global equities.
For those who believe hosting is more important
than winning, we have also investigated stock
market performance in countries that have hosted
World Cups. World Cup hosts, on average, slightly
outperformed MSCI World after the event, though
with high dispersion. For example, Germany outperformed MSCI World by 16.9% during the three
months after hosting (and winning) the 1974 World
Cup, while Spain and Italy underperformed by
11.6% and 10.4% three months after hosting
the 1982 and 1990 World Cups, respectively (see
Fig. 2.4).
Fig. 2.3: World Cup winners and subsequent
local market performance
Winner performance vs. MSCI World
Year
Winner
1 week
1 month
3 months
1974
Germany
1.3%
7.0%
16.9%
1978
Argentina
na
na
na
1982
Italy
–3.3%
8.5%
–11.6%
1986
Argentina
na
na
na
1990
Germany
–1.8%
–0.1%
–12.6%
1994
Brazil
–0.1%
16.2%
22.7%
1998
France
–0.1%
–1.2%
–8.8%
2002
Brazil
–3.4%
–6.6%
1.8%
2006
Italy
0.8%
0.3%
2.0%
2010
Spain
–1.3%
1.0%
–6.0%
Median
–0.7%
0.7%
–2.1%
Average
–1.0%
3.2%
0.5%
Note: Data refer to relative price return of MSCI country indices versus
MSCI World. No data available for Argentina in 1978 and 1986
Source: UBS, Datastream
What does the World Cup mean for Brazil’s standing in the developing world?
Fig. 2.4: World Cup hosts and local market performance
Host performance vs. MSCI World
Year
Host(s)
1974
Germany
1978
Argentina
1982
Spain
1986
Mexico
During
1 week
1 month
3 months
4.1%
1.3%
7.0%
16.9%
na
na
na
na
–1.8%
–3.3%
8.5%
–11.6%
na
na
na
na
1990
Italy
–5.2%
–2.1%
–2.6%
–10.4%
1994
US
–2.8%
0.7%
1.9%
2.1%
France
–1.1%
–0.1%
–1.2%
–8.8%
Japan
–2.3%
1.7%
3.0%
7.7%
1998
2002
2006
2010
Korea
0.5%
6.6%
5.5%
4.3%
Germany
1.1%
–1.3%
–0.9%
2.3%
1.5%
1.6%
–2.8%
–1.8%
Median
South Africa
–1.1%
0.7%
1.9%
2.1%
Average
–0.6%
0.6%
2.0%
0.1%
Note: Data refer to relative price return of MSCI country indices versus MSCI World.
No data available for Argentina in 1978 and for Mexico in 1986
Source: UBS, Datastream
Based on historical evidence, investors should
expect little meaningful economic or financial
market impact from the World Cup, either on
the winning or hosting country. However, given
the particular political juncture Brazil is facing and
an already unstable social situation, the World Cup
could have a more sizable effect than normal. If
the existing infrastructure proves insufficient or
protests cause severe disruption, this may further
sour global investors’ negative sentiment towards
Brazil or even emerging markets, in general. If
Brazil fails to win the Cup, the mood on the streets
could get much worse.
Paradoxically, this type of negative scenario could
put upward pressure on markets if it tilts voters
against the government of incumbent president
Dilma Rousseff. Given that opposition candidates Aecio Neves and Eduardo Campos are both
expected to embrace more market-oriented policies, bad news for Rousseff may be good news
for the markets. However, this upward pressure
on stocks may be as fleeting as the World Cup.
As protesters in the streets may already suspect,
curing Brazil’s structural ailments is likely to involve
a period of bitter medicine – no matter who wins.
Conclusion
As the reader can see, there is little relationship
between Brazil’s footballing and economic performance. World Cup success in both the games and
their organization would enhance Brazil’s image
in the world. The opposite may be true for the
markets, however. Anything that enhances the
likelihood of President Rousseff’s reelection will
likely be perceived as a perpetuation of the policies
that created Brazil’s problems in the first place.
The World Cup, however, is a passing event. Social
discontent in Brazil is merely symptomatic of the
wider problems facing the country, including poor
provision of public services, corruption, creaking
infrastructure, and a dissatisfied middle class.
Resolving these problems, rather than winning
the World Cup, is what is needed to lift Brazil’s
economy and markets in a more durable manner.
World Cup 2014 in Brazil
5 June 2014
11
Section 3
And the World Champion
is…
Andreas Hoefert, Chief Economist and Regional CIO Europe, UBS FS
[email protected]
With just days to go before the 2014 World Cup,
I have finally yielded to requests to pick a favorite,
following my attempts at the last two tournaments
in 2006 and 2010.
Admittedly, I am not a full-time soccer expert.
But the econometric tools used to forecast the
likes of business cycles and inflation rates are still
better at predicting football results than a throw
of the dice. With so much at stake economically
and financially in this year’s tournament, modeling the outcome is also desirable from a research
perspective.
Of course, these predictions may diverge greatly
from the results. In 2006, I defied expert consensus
and forecast correctly that Italy would win. This
gave me a bizarre six minutes of fame discussing
football as an economist on CNN. However, in
2010, while my model did yield some predictive
fruit, I was far less accurate than Paul, a twoyear-old octopus from Sea World in Oberhausen,
Germany. When asked to predict the outcome of
eight World Cup games, Paul correctly forecast
all of them, including the finals.
Underperforming a mollusk was humbling to
say the least. Moreover, while my model has
some value when it comes to the World Cup, it
is absolutely useless at predicting the outcome
of European Championships. So readers should
approach the following with caution, as well as a
touch of humor. After all, no animals were harmed
in the making of this research (not even an octopus). And in case anyone grumbles that I have
wasted working hours on these trivialities, I can
assure you that all computations were performed
12
5 June 2014 World Cup 2014 in Brazil
in my spare time – econometrics being one of my
(admittedly weird) hobbies.
Past forecasts
As mentioned, during the last two World Cups my
model had a certain amount of predictive power.
In addition to the winner in 2006, it picked 13
out of 16 second round teams, six out of eight
quarter-finalists, and one out of four semi-finalists.
Running the model again after contestants qualified for the second round increased this to 50%
of all semi-finalists.
In 2010, the performance was not as good. Brazil
was the favorite, by a small margin, and Spain was
only given a 4% chance of winning, despite being
one of the experts’ top favorites. But the model
was still able to pick 11 out of 16 second round
participants, five out of eight quarter-finalists, and
50% of all semi-finalists.
Overall, when it comes to World Cup results, there
are only three statistical factors with predictive
power:
1.an objective measure of the strength of each
team before the World Cup – the so-called Elo
rating;
2.past performance;
3.which team is hosting.
By contrast, socio-economic factors like size of
GDP, growth rate or population have no predictive power. So far only eight teams have won at
least one World Cup, three from Latin America
and five from Europe. Economically and size-wise,
these have been rather diverse.
And the World Champion is…
Objective strength
As in our two previous World Cup forecasts, this
time around we use the Elo rating of each team
as of mid-May before the World Cup to measure
objective strength. This rating was developed
by the Hungarian-American physicist Arpad Elo
(1903–1992) to measure and rank the strength
of chess players. The ratings have been used in
other sports like tennis, but especially in football.
They are a better predictor of teams’ objective
strength than the FIFA ranking system.
The Elo method takes into account not only the
number of wins, losses and draws for each team,
but also the conditions under which they occurred.
Beating a strong team like Brazil or Spain will
improve a team’s Elo ranking much more than
beating a weaker team like Malta or Andorra.
Winning abroad gets a team more points than
winning at home. Winning a World Cup qualifier
gets more than winning “a friendly.” Winning 5–0
gets more than winning 2–1.
Elo ratings can also compare the strength of
teams across times. For example, the Brazilian
team that won the World Cup in 2002 was significantly weaker than the one that won it in 1962.
According to this measure, the Spanish team that
won the World Cup in 2010 was in fact the strongest team ever to win a World Cup. (More detail on
the ratings can be found at www.eloratings.net.)
According to the Elo ranking, this year’s World
Cup is the strongest ever. With an Elo rating of
1920, the 16 best teams average roughly what
was needed by Brazil to win the World Cup in
1994. Moreover, three teams have an Elo rating
above 2000. Brazil will go into the World Cup
with a higher Elo rating than any team that has
ever entered. Spain will also start with its highest Elo rating ever, or 2085, larger than its 2078
rating prior to the 2010 World Cup. Uruguay will
enter the World Cup with its highest Elo rating
ever before such a competition, while Germany
will present its second-highest Elo rated team, as
will Argentina. The Dutch, English, Portuguese,
Italian and French teams have all mustered Elo
ratings above 1870, or higher than Italy’s before
it won the World Cup in 1982.
Past performance and hosting
But while no team with an Elo rating below 1820
has ever won a World Cup, those ratings alone
are not sufficient to explain the performance of a
World Cup team. In fact, no favorite based solely
on Elo ratings has ever won the World Cup, with
the exception of Germany in 1974.
Some teams have traditionally outperformed their
own rating, such as Germany, Italy, or Argentina,
and others have sometimes severely underperformed, especially England and, until the last World
Cup, Spain. So past performance at the World Cup
is another factor with significant predictive power.
As mentioned, only eight teams have won at least
one out of the 19 World Cups so far. In 2010, Spain
was an outlier. Not only did it enter the exclusive
club of World Cup winners, but it also made it
into the final, an achievement matched by only six
teams (Brazil, Italy, Germany, Argentina, France and
the Netherlands) in the past 10 World Cups. The
semi-finals are usually more open. Nonetheless,
52.6% of all final four spots have been taken
by just five teams (Brazil, Germany, Italy, France
and Uruguay) since the World Cup began. Since
1970, more than 70% of all final four spots were
taken by six teams.
Whether a team hosts is also crucial. The World
Cup in 2010 was the first in which the hosting
nation (South Africa) failed to enter the final
rounds. Admittedly, South Africa started the competition with the lowest Elo rating of any other
team. Overall, however, over 30% of all hosting nations have won the World Cup and over
60% have reached the final four. In addition, no
European team has ever won a World Cup hosted
in Latin America and only one Latin American
team managed to win the World Cup in Europe
(Brazil in Sweden in 1958).
The second round
Our model has been rather good in forecasting
the final sixteen participants in the previous two
World Cups. As mentioned above it managed to
forecast thirteen participants in 2006 and eleven
in 2010. Ex ante forecasting (i.e., only using the
information available back then) shows that our
model would have predicted 15 of the final 16
teams in the 1998 World Cup and 12 of the final
16 in 2002.
World Cup 2014 in Brazil
5 June 2014
13
Section 3
However, this World Cup warrants a little more caution. There are first round groups with strange compositions. Some groups have more than two clear
favorites, like ‘death group’ D, where Uruguay, Italy
and England have each a roughly 60% chance of
making it into the second round. Other groups
have one clear favorite and three equal outsiders, like group F, where Bosnia, Nigeria and to a
lesser extent Iran have an almost equal chance of
finishing second behind Argentina.
Fig. 3.1 gives you 22 teams that are most likely
to make it into the second round. Assuming that
all second round teams are in this table, then
there is an almost 90% chance that at least 11
of the first 16 will make it into the second round.
However, there is only a 0.001% chance that the
first 16 teams in this table will qualify. The fact
Fig. 3.1: Probability of qualifying for the second
round
Team
Group
Probability (in %)
1
Argentina
F
99
2
Brazil
A
95
3
Germany
G
81
4
Russia
H
75
5
Colombia
C
71
6
Belgium
H
70
7
France
E
69
8
Spain
B
69
9
Uruguay
D
60
10
Netherlands
B
59
11
Italy
D
58
12
Ecuador
E
57
13
Portugal
G
56
14
Mexico
A
50
15
Ivory Coast
C
45
16
Bosnia Herzegovina
F
36
17
England
D
57
18
Chile
B
52
19
Switzerland
E
52
20
Greece
C
45
21
US
G
44
22
Nigeria
F
33
Source: UBS
14
5 June 2014 World Cup 2014 in Brazil
that Argentina is even more likely to make it than
Brazil is simply because its opponents in group F
are even weaker than Brazil’s in group A.
Second round case studies: Brazil,
Switzerland, and the US
With no first round surprises, host Brazil, which has
an easy first round group, will face the Netherlands
for a place in the final eight, Italy in the quarter final
and Germany in the semis, before either Spain or
archenemy Argentina in the final. Until the final,
this could be seen as a “walk in the park” for the
host country, albeit of a more menacing variety.
However, if Uruguay comes second in its group,
or if France beats Germany in the quarterfinals,
the situation would change. Brazil would have
to face two of its historic nemeses before it even
reached the final. Even though the story is now
64 years old, every Brazilian soccer fan still mourns
the fact that Uruguay beat Brazil on Brazil’s home
turf to win its second World Cup in 1950. France
has also beaten Brazil in 1986 (in the quarters),
1998 (in the final) and 2006 (in the quarters again).
If Switzerland comes first in its group, then the
final-eight contender (one of Bosnia, Nigeria or
Iran) should be manageable. However, to beat
Germany in the quarterfinal would be a huge
exploit. If it ends second, it would likely face
Argentina in the final eight.
With Germany (one of the clear favorites) and
Portugal in its group, it will be difficult for the US
to make it to the second round. If it does, it would
likely face Russia, Belgium, or South Korea in the
final eight, taking into account South Korea’s knack
for World Cup shocks. All three are manageable,
although Belgium is seen as one of the most promising outsiders by many true experts. The quarter
finals would be rather tougher because the US
might face either France or Argentina.
The final four
Fig. 3.2 lists the 11 most likely ‘final four’ teams
and Fig. 3.3 the seven most likely winners. None
of the names are unexpected. All of them have
strong Elo ratings and past performance in World
Cups. With the highest Elo rating of any team
prior to a World Cup, Brazil is clearly the favorite. However, this role demands strong nerves,
especially given domestic pressure on the team
And the World Champion is…
Fig. 3.2: Probability of qualifying for the
semi-finals
Fig. 3.3: Probability of winning the World Cup
Team
Probability (in %)
Brazil
30
Argentina
12
40
Spain
9
Germany
38
Germany
8
Netherlands
24
Uruguay
8
Argentina
23
Netherlands
3
Italy
20
Italy
3
France
18
Portugal
15
Uruguay
15
England
14
Chile
12
Team
Probability (in %)
Brazil
62
Spain
Source: UBS
Source: UBS
and the debacle when Brazil hosted 64 years ago.
It is not inconceivable that Uruguay could be a
surprise finalist for Brazil if it comes out first of its
very strong group. Plus, as mentioned, favorites
on an Elo basis have also almost never won the
tournament.
Surprise performers
This model tries to calculate the most likely results,
so by definition it cannot single out this year’s “surprise teams” – the likes of South Korea or Turkey
in 2002, or Croatia in 1998. Given that this World
Cup is taking place in Latin America and that the
Latin American teams are very strong, the likes
of Chile, Colombia and Ecuador could provide a
shock contestant for the final four.
Nevertheless, picking the biggest negative surprise
is easy. As the strong favorite, as the host, and as
a soccer-mad country in election year, Brazil may
view defeat as a national disaster – let alone an
early exit. Financially speaking, the electorate is
much less likely to forgive the sums spent on the
World Cup if their own team fails to carry home
the trophy – with consequences outlined in the
first two articles of this report. Nevertheless, we
reiterate our view that Brazil is the strong favorite,
and that the risks it has taken as a host nation
have a good chance of paying off.
And with that, let the tournament begin!
World Cup 2014 in Brazil
5 June 2014
15
Appendix
Investing in Emerging Markets
Investors should be aware that Emerging Market assets are subject to, amongst others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and sociopolitical risk, interest
rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen. WMR generally
recommends only those securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities
Exchange Act of 1934) and individual State registration rules (commonly known as “Blue Sky” laws). Prospective investors should be
aware that to the extent permitted under US law, WMR may from time to time recommend bonds that are not registered under US
or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not
as frequent or complete as that required by US laws.
For more background on emerging markets generally, see the WMR Education Notes, “Emerging Market Bonds: Understanding
Emerging Market Bonds,” 12 August 2009 and “Emerging Markets Bonds: Understanding Sovereign Risk,” 17 December 2009.
Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit
ratings (in the investment grade band). Such an approach should decrease the risk that an investor could end up holding bonds on
which the sovereign has defaulted. Sub-investment grade bonds are recommended only for clients with a higher risk tolerance and
who seek to hold higher yielding bonds for shorter periods only.
Disclaimer
Chief Investment Office (CIO) Wealth Management (WM) Research is published by UBS Wealth Management and UBS Wealth Management Americas, Business Divisions of UBS AG (UBS) or an affiliate thereof. CIO WM Research reports published outside the US are
branded as Chief Investment Office WM. In certain countries UBS AG is referred to as UBS SA. This publication is for your information
only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis
contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment
strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could
result in materially different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax)
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