Itaú BBA - Encouraging signs, still cautious

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Encouraging signs, still cautious

August 21, 2012

A greater number of consumer-oriented sectors reported recovery in output and sales from July to early August.

With information through August 17, 2012

This report, published six times per year, summarizes anecdotal information on current economic conditions received from key business contacts, economists, market experts, and other sources outside Itaú. Apart from the “our view” section, it is not a commentary on the views of Itaú’s Macroeconomic Research team.

Contents

Consumption and Production of Goods and Services
A greater number of consumer-oriented sectors reported recovery in output and sales from July to early August. A cautious mood, however, prevails.
Investment
Business confidence remains subdued. But pick up signs in demand in some sectors reduce the worries reported in recent months and bring some optimism.
Real Estate
Activity in the real estate sector continues to expand at a moderate pace.
Commodities
Higher prices, weaker currency and the good harvest in the middle of the year are driving positive results in the agricultural sector.
Labor Market, Wages and Prices
Remarks on employment were more mixed than in previous editions of the Orange Book, though overall they still describe a relatively tight labor market. 
Our View
The economy should benefit from economic stimulus. We expect the economy to accelerate in the second half of the year. Some green shoots of recovery are becoming visible.


Summary

A greater number of consumer-oriented sectors reported recovery in output and sales from July to early August, particularly those benefited by government incentives. A cautious mood, however, prevails. Inventories came down, and seem more adjusted to normal levels.

The auto industry is reporting better results, while household-appliance producers expect a slowdown from the first half.

Segments tied to current income – such as personal care products, medication, food and beverages – have experienced robust sales in the beginning of the second half. As in other editions of the Orange Book, the solid expansion of service sectors remains on track.

Business confidence continues to be subdued. But pick up signs in demand in some sectors reduce the worries reported in recent months and bring some optimism.Infrastructure investment is gradually accelerating, as the FIFA World Cup™ and municipal elections near.

Activity in the real estate sector continues to expand at a moderate pace. Sales speed is characterized as reasonable, but still focused on reducing inventories, which remain relatively high. Launches should be fewer than last year.

Higher prices in international markets, weaker currency and the good harvest in the middle of the year are driving positive results in the agricultural sector in Brazil. A more stable and weaker exchange rate also benefits industrial commodity segments, such as steel and mining.

Remarks on employment were more mixed than in previous editions of the Orange Book, though overall they still describe a relatively tight labor market.  The increase in labor costs continues to be a problem in many sectors. Higher labor costs and exchange-rate fluctuations should not pressureprices, given the severe competition in consumption markets.

Our view: the economy should benefit from past and future economic stimulus. We expect the economy to accelerate in the second half of the year. There are risks. But, in general, policy incentives appear to be finally spurring demand, and some green shoots of recovery are becoming visible.

Consumption and Production of Goods and Services

A greater number of consumer-oriented sectors reported recovery in output and sales from July to early August, particularly those benefited by government incentives. A cautious mood, however, prevails. Regional differences described in our last Orange Book continue, with more favorable reports from the North and Northeast than from the South and Southeast.

Inventories seem more adjusted, except in some cases, such as household appliances. Our proprietary survey reflects an increase in the number of companies with adequate inventory levels, though the percentage of companies with excessive inventories is relatively high (above pre-2011 levels).

Following a very weak first half, the auto industry is reporting better results. The IPI tax cut drove sales from June onward, and production started to react in July and August. More orders are being placed with auto-parts manufacturers, confirming this trend.

In the opposite direction, household-appliance segments expect a slowdown from the first half, as the initial impact of tax incentives adopted early in the year fades. Inventories are on the rise again, suggesting a slower pace of production ahead.

Segments tied to current income – such as personal care products, medication, food and beverages – have experienced robust sales in the beginning of the second half, though results are still in line with or even below what was forecasted last year.

As in other editions of the Orange Book, the solid expansion of service sectors remains on track. Segments such as restaurants, hospitality, education and outsourced services (cleaning, security) continue to report strong demand. On tourism, recent public and private investments, specially related to the FIFA World Cup™, are bringing good prospects.

On the supply side, output is still limited by higher costs and competition from abroad. Concern about the sustainability of demand recovery and the complex international scenario also weigh on production decisions. The signs of a rebound and the already-implemented economic stimulus, however, suggest a pickup in the production of consumer goods in coming months.

Investment

Business confidence remains subdued. Our indicator, based on a survey with a broad range of clients, has been roughly flat since mid-2011 and about 15% lower than in the end of 2010. But pick up signs in demand in some sectors reduce the worries reported in recent editions of the Orange Book and bring some optimism.

Most sectors explain their conservative approach towards investment by mentioning the complex external environment and the uncertainty regarding the domestic rebound. Frequent tax measures focused on specific sectors cause some loss of visibility, delaying capital expenditures.

Even in segments reporting strong demand, investment decisions are not immediate. In the 2010/2011 cycle, many companies prepared themselves for even faster growth than observed now, and therefore have spare capacity.

At the same time, some government measures are starting to have a positive effect. Incentives for national content improved the outlook for foreign direct investment in the capital-goods sector, the automotive industry and others. A weaker and less volatile exchange rate brings optimism, particularly to commodities producers and those sectors that compete with imports.

Infrastructure investment is gradually accelerating, as the FIFA World Cup™ and municipal elections near. The perception, however, is of no major change in urban infrastructure, but rather a marginal relief of bottlenecks. The process, sometimes complex, to approve construction projects (authorizations, bidding processes, etc.) is mentioned as an obstacle for increasing expenditures.

In the heavy-vehicle sector, the scenario remains challenging. Buyers are little inclined to purchase trucks using the new Euro 5 technology (less pollution, with higher production cost), as they have no assurance of finding compatible fuel in gas stations. In turn, gas-station owners are hesitant to carry the new fuel, as demand is uncertain and the product perishes quickly.

On the other hand, the good momentum of the agriculture sector – strong production, high prices – has positive impacts on the heavy-vehicle sector. Sales of trucks and agricultural machinery in some regions (in the Center-West, for example) keep improving, particularly as government incentive programs get more intense.

Real Estate

Activity in the real estate sector continues to expand at a moderate pace. Sales speed is characterized as reasonable, but still focused on reducing inventories, which remain relatively high. Launches should be fewer than last year. Supply and demand seems balanced; property prices tend to remain relatively stable this year.

The positive effects of interest-rate cuts are being felt gradually. There is higher demand for investment properties, both residential and commercial.

Higher labor costs remain a concern, while other input costs have been stable.

Commodities

Higher prices in international markets, weaker currency and the good harvest in the middle of the year are driving positive results in the agricultural sector in Brazil. Low inventories in the U.S. and in China should keep the market tight.

Poor infrastructure and logistic facilities limit exports, preventing the country from taking full advantage of the favorable moment.

The good performance of the agricultural sector is also reflected in the fertilizer segment. Growth in Brazil is above the average for other countries which are important consumers of fertilizers, such as China. For now, international fertilizer prices have not followed the increase in grain prices, so the product is relatively cheap for farmers.

The sugar and ethanol sector does not share the good results of other agricultural segments. Sugarcane yields are low and heavy rains hurt the sector between the end of the first half and the beginning of the second. There is not enough sugarcane to be crushed, and spare capacity at mills runs at about 40%. Looking ahead, the regulated prices are mentioned as a factor inhibiting new investments.

A more stable and weaker exchange rate also benefits industrial commodity segments, such as steel and mining. Export profitability is recovering (although volumes remain low) and imported items are less competitive in the local market. Steel producers also benefit from the IPI tax cut for steel-intensive white goods and automobiles. Thus, the sector has reported acceleration in sales in recent months.

Labor Market, Wages and Prices

Remarks on employment were more mixed than in previous editions of the Orange Book, though overall they still describe a relatively tight labor market.  

In response to low economic growth, some sectors have expressed their intention to reduce personnel after holding back layoffs in recent quarters. In some cases, the process has already started.

Most sectors, however, are still reporting difficulties in hiring skilled and unskilled workers, and a need to raise wages above inflation to retain workforce. The increase in labor costs remains a problem in many sectors, from services to construction and even in some industrial segments.

Sectors that have started to perceive a clearer pickup are gradually reconsidering plans of layoffs. Even among those still experiencing weak activity, often the preference is still for mandatory vacations instead of layoffs. 

Worker productivity is generally regarded as low. Thus, many sectors are accelerating automation and personnel-training efforts. The results of these initiatives should materialize in the medium to long run.

Higher labor costs and exchange-rate fluctuations should not pressure consumer prices in the short term. Severe competition drives companies to increase efficiency and cut costs to avoid further margin compression.

This reality should also limit the inflationary effects of higher international grain prices.

Our View

The economy should benefit from past and future economic stimulus, especially measures to prop up investment and reduce costs in the manufacturing sector. We expect the economy to accelerate in the second half of the year.

There are risks, however. A reversion of the labor market’s strong conditions, for instance, could interrupt the recovery cycle for consumer spending. Similarly, a possible deterioration in the international scenario, particularly in Europe, would also hinder growth recovery in the next months.

But, in general, recent information suggests that risks are lower. Policy incentives appear to be finally spurring demand, and some green shoots of recovery are becoming visible.



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