Macro Vision July 25, 2016 Is Brazil coming out of the recession? Leading indicators already show some positive signs for activity. Does this mean that the economy is already coming out of the recession? We developed an indicator to measure the economy s momentum, and the results suggest that the recession continues although there are some signs of improvement. Introduction Leading indicators already show some positive signs for activity in Brazil. The market environment, measured by asset-price behavior, has posted a significant improvement since March, returning to expansionary territory. On the industry side, there are signs of stability in demand and a decline in inventories. Some recent data surprised to the upside, such as GDP growth in the first quarter. Do these signs mean that the economy is finally changing course? Can we affirm that Brazil is coming out of the recession? We developed an indicator that measures activity momentum, i.e., that indicates whether growth is gaining traction. The indicator suggests that the economy is still in recession, although there are some signs of improvement. Momentum activity indicator Our goal is to assess the momentum of the Brazilian economy; in other words, to assess whether the economic activity in the country is gaining or losing traction. We developed a coincident indicator based on two subcomponents. The first covers industry, while the second subcomponent covers the services sector. We used monthly seasonally adjusted data starting in January 2000 1. The momentum indicator is based on data that capture the various aspects of actually observed economic activity, rather than confidence indicators, for both corporations and households. We built our indicator using the principal-components method, considering the annualized quarterly growth rate of each variable. When the indicator is below (above) zero, this means that the economy or the sector is growing below (above) the historical average. Industry Subcomponent In order to measure changes in the industrial sector, we used the following variables: industrial production (IBGE), electricity consumption (ONS), vehicle production (Fenabrave), heavy-vehicle traffic (ABCR), cardboard paper sales, capacity utilization (FGV), hours worked in industry (CNI) and net creation of formal jobs in the sector (Caged). As shown in the chart below, the sector had already started to feel the effects of recession by the end of 2012. At the margin, there are now some signs of recovery. There was a slight acceleration of growth in the sector, thus the subcomponent is no longer close to the lows observed at the end of 2015. However, the indicator is still below zero, which means that growth has remained below the historical average in recent months. 1 For more details, see the appendix. Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the single factor in making their investment decision.
4 3 Industry Subcomponent Values above zero indicate sector growth above the historical average. 2 1 0-1 -2-3 -4 3M-MA Monthly -5 Sep-99 Jan-03 May-06 Sep-09 Jan-13 May-16 * Index is measured as the standard deviation with respect to its historical value. Source: Itaú Services Subcomponent For the services-sector subcomponent, we considered retail sales (IBGE), light-vehicle traffic (ABCR), supermarket sales (Abras), electricity consumption in commercial establishments and households (ONS) and net creation of formal jobs in the sector (Caged). The chart below shows that the services sector follows different dynamics than industry. While industrial activity started to recede by the end of 2012, the services sector was only affected at the end of 2014. Recently, signs of improvement in the sector are less clear. Since May 2015, the indicator has been showing greater volatility, as there is still little evidence of consistent improvement. 3 2 Services Subcomponent Values above zero indicate sector growth above the historical average. 1 0-1 -2-3 3M-MA -4 Monthly Sep-99 Jan-03 May-06 Sep-09 Jan-13 May-16 * Index is measured as the standard deviation with respect to its historical value. Source: Itaú Momentum activity indicator Based on the services and industry subcomponents, we built an indicator of activity momentum for the Brazilian economy, weighing each subcomponent by its correlation with GDP. The indicator started to show signs of contraction in activity in the beginning of 2014 and the slight improvement in the third quarter of 2014 was not enough to reverse the downward trend. At the margin, the indicator already shows that economic activity is gaining traction, driven by the industry component. However, activity remains below the historical average. Page 2
3 2 Activity Momentum Indicator Values above zero indicate sector growth above the historical average. Is the economy still in recession? 1 0-1 -2-3 3M-MA Monthly -4 Sep-99 Jan-03 May-06 Sep-09 Jan-13 May-16 * Index is measured as the standard deviation with respect to its historical value. Source: Itaú The economic improvement captured by our momentum indicator has probably not been enough to take the economy out of the recession. We used the methodology proposed by Hamilton (1989) to calculate the probability that the economy is under a recession or in an expansion period. The chart below shows the estimated probability. We consider the economy in recession when the probability is at least 65%. This value is based on the average of probabilities in the periods of early recession, which were established by CODACE (Economic Cycles Dating Committee, FGV). Considering the most recent data, from May 2016, the probability of recession remains close to 100%, underscoring that the recent improvement has not been enough to reverse the recessionary trend. Conclusion Recession Probability 100% 99% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Dec-00 Oct-04 Aug-08 Jun-12 Apr-16 * The grey areas correspond to periods of recession according to CODACE. Source: FGV,Itaú We built an indicator of the momentum of Brazilian activity, which measures variables growth pace. Based on the results, we conclude that the Brazilian economy is already showing signs of improvement, although it is still Page 3
in recession. Note that for the end of recession to be confirmed, the improvement will have to continue over the coming months. In our base scenario, where economic reforms especially on the fiscal front continue to advance, we expect the economy to resume expansion. Laura Pitta André Matcin Appendix A) Data used: For paper cardboard dispatches, level of capacity utilization and hours worked in industry, we extended the series to encompass the considered period, using data correlated with these variables. Category Series Source Services Retail Sales Pesquisa mensal do comércio - IBGE Services Traffic of light vehicles Associação Brasileira de Concessionárias de Rodovias (ABCR) Services Supermarket Sales Associação Brasileira de Supermercados (ABRAS) Services Formal Job Creation (Commerce; Services; Public Adm.) CAGED - Ministério do Trabalho e Previdência Social Services Electricity consumption (GWh) - Household Empresa de Pesquisa Energética Services Electricity consumption (GWh) - Commerce Empresa de Pesquisa Energética Industry Industrial Production Pesquisa Industrial Mensal de Produção Física - IBGE Industry Civil construction inputs Pesquisa Industrial Mensal de Produção Física - IBGE Industry Electricity consumption (GWh) - Commerce Empresa de Pesquisa Energética Industry Industry Truck Sales Traffic of Heavy Vehicles Federação Nacional da Distribuição de Veículos Automotores (Fenabrave) Associação Brasileira de Concessionárias de Rodovias (ABCR) Industry Paper Cardboard Dispatches Associação Brasileira do Papelão Ondulado (ABPO) Industry Capacity Utilization Fundação Getúlio Vargas (FGV) Industry Hours worked in industry Confederação Nacional da Indústria (CNI) Industry Formal Job Creation (Mining; Transformation Industry; Public Utility; Civil Construction) CAGED - Ministério do Trabalho e Previdência Social Page 4
B) Methodology: To estimate the probabilities of recession and expansion, we considered a regime-change model based on a Markov chain, as proposed by Hamilton (1989). The results of the estimated model follow below: Model to estimate expansion and recession probabilities Sample: Oct/1999 - May/2016 Variable Coefficient P-value Constant Regime 1 (Recession) -1.30 0.000 Regime 2 (Expansion) Constant 0.31 0.006 Common coefficients to both regimes AR(1) 0.99 0.000 AR(2) -0.08 0.450 AR(3) -0.40 0.000 AR(4) 0.21 0.006 Log(Variance) -0.89 0.000 Reference HAMILTON, J. A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica, [S.l], v. 57, n. 2, p. 357-384, Mar. 1989. Macro Research Itaú Tel: +5511 3708-2696 Click here to visit our digital research library. Page 5
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