Thread by @Matt_Cochrane7

1/ Buckle up, this is a long thread mostly on why $XP, a Brazilian digital stock brokerage, is IMO wildly overvalued and benefiting from temporary macro factors.

But also touches on why other Brazilian stocks, e.g. $MELI, $PAGS, $STNE, might be affected from same factors.

2/ Let's start with $XP. $XP was brought to my attention earlier this year as digital brokerage that was growing like gangbusters. The pitch was that Brazilians had discovered investing and this was a way to capture Brazil's middle class upside.

Its 2020 Q1 numbers were amazing!

3/ I did have a few questions:

Why was a 20-yr old brokerage now growing 80% YOY?

Why were Brazilians suddenly pouring money into brokerages and investing?

Brokerages are largely commoditized, so what was $XPs long-term moat, besides possibly gaining scale?

4/ Biggest question though was some puzzling comments from mgmt re:interest rates. Mgmt wanted lower rates, not higher.

Brokerages normally earn money from the interest earned on cash balances held in client accounts, so the higher the better. See #1:

investopedia.com/articles/inves…

5/ This puzzled me. Why would any brokerage want lower interest rates? Why was $XP suddenly growing so fast? A digital brokerage solution just isn't that innovative in this day and age, right?

But growth was real and mgmt's insistence on wanting lower rates

6/ Aside: Now, on some level, it does make sense that a stock brokerage would want lower rates. $XP's mgmt picks at that reasoning in these comments. Lower rates would lead to less interest in fixed income assets and more interest in stocks. Mgmt gets at that reasoning here

7/ But there's more to it than how many American investors (including me) would interpret these comments. And to understand why, one has to understand Brazil's financial landscape, including Selic rates, inflation, agriculture, and savings accounts,

8/ Brazil's central bank sets the "Selic" rate, which is like the Federal Reserve rate here in the U.S.

bcb.gov.br/en/monetarypol…

9/ As recently as 2017, Selic rates were in double-digits, but in recent years it has plummeted.

bcb.gov.br/en/legacy?url=…

10/ When rates were high, Brazilian middle class mostly used tax-free, insured savings accounts to save. And why not? Most investors would be set with guaranteed, tax-advantaged double-digit rates of return! But as rates have fallen, investors have rushed into equity accounts.

11/ That explains why a 20-yr old brokerage is now growing 80% YOY. 18 mos ago this was described as a "gold rush" of investors looking for higher yields.

11/ Here's the problem: Brazil incentivizes these savings accounts b/c banks are regulated to direct this money towards investments in agriculture, an important industry in Brazil.

Plus inflation is a real problem in Brazil, which keeps pressure on rates to stay higher.

12/ So now question becomes whether Brazil will raise Selic rates again. If inflation creeps up/if further investments in agriculture are needed, it will have to. I can't predict U.S. interest rates, so I would never predict Brazil's Selic rates. But ...

13/ Copom, Banco Central do Brasil's monetary policy committee, again cut rates earlier this year, but at same time also said it is projecting to raise them by ... 2021.

spglobal.com/marketintellig…

14/ Now that could easily change, again I am last person on earth to predict any interest rate projections in Brazil! But if it doesn't why wouldn't Brazilian savers move their money back out of investment accounts, into high-interest, guaranteed, tax-advantaged savings accounts?

15/ The flood could easily shift into an exodus. Why would anyone want to base investment thesis on what Brazilian Selic rates will do in future?

I have more thoughts on $XP, but will get back to them at the end. For now, let's quickly turn back attn to $MELI $STNE $PAGs etc

16/ Investors are notorious for showing home country bias, meaning they will pour money into investments from their own country before looking at foreign opportunities. This is proven in many studies.

alphaarchitect.com/2019/12/05/glo…

17/ Just a thought, but I wonder if high-growth Brazilian stocks, such as $MELI $PAGS $STNE etc, have done so well due to same phenomena of Brazilian investors rushing into equity markets last 1-2 yrs. I like all these companies - and long $MELI - but ...

https://twitter.com/HayekAndKeynes/status/1289632303530958848

18/ Back to $XP, it is also facing other headwinds. Itau Bank $ITUB, largest private bank in Brazil, owns 49.9% stake in XP and has faced regulations to keep it from investing in XP's growth at times due to competitive market:

From: bloombergquint.com/business/guilh…

19/ Meanwhile digital brokerages are now dotting Brazilian investment landscape. Genial is growing particularly fast and also owned by a large Brazilian bank:

bloomberg.com/news/articles/…

20/ A former $XP partner is teaming up with XP's co-founder to launch a competitor:

21/ This was after $XP's compensation on sales was called into question, sounding similar to recent Robinhood and $WFC stories.

22/ I have no idea how XP will fare in future and would welcome feedback from more experienced int'l investors and others who I know are bullish on XP. I think story is tied to factors not understood by many.
@saxena_puru @JoeySolitro @andrescardenal @LuisMiguelValue

Also caveat: Yes, I know $MELI isn't Brazilian, it's Argentinian. But investors there are familiar with it b/c so much of its business is conducted there. Same principle I believe.