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PLANNER REDWOOD ASSET MANAGEMENT MONTHLY COMMENTARY - OCTOBER 2018 Monthly Commentary – October 2018 Agenda Introduction Economic Outlook Fiscal Policy International Outlook Interest Rates Foreign Exchange Stock Market 2 Monthly Commentary – October 2018 Epigraph of the month... a propos of Brazil’s current predicament. “Economists may be more naïve about politics than politicians about the economy” Eduardo Giannetti – Brazilian Economist. 3 Monthly Commentary – October 2018 Introduction Brazil has a new president-elect: Jair Messias Bolsonaro. The election of Jair Bolsonaro is a milestone in Brazil's history, not only by breaking the decades-long polarization between PT and PSDB, but mainly because of his 10 million votes margin ahead of his opponent. A victory based on the campaign promises that result in a strong repositioning of Brazilian society. This is a shift towards the right-wing policies, a huge step regarding what we have experienced in the economy, domestic and foreign policy, education, culture, health and public safety. In fact, our society’s disgust comes from the various crises we are going through. The economic crisis that devastated the country, with consequences so harmful to both employment and income, accompanied by rampant corruption, also stirred up the yearning to recover the morale of our people. Jair Bolsonaro represents this sentiment, that is, an alternative path to our ills; a point off the curve in relation to the politically correct and a hope of realignment of forces toward order and progress. Its little explored platform of government contains the essence of what is expected: not a savior of the fatherland, but a technical and honest government... enough to start up the reconstruction of Brazil. On the side of structuring a technocratic government, it seems that we will have a government with "Superministers" - and all with full autonomy to assemble their teams. Among them we can cite Paulo Guedes (Economy), Marcos Pontes (Science and Technology), General Augusto Heleno (Defense) and Sérgio Moro (Justice), all with exemplary qualifications for future positions. This initial line-up does not deviate from the promises of the campaign, whilst also appealing to investors and improving expectations (stock market rises and Dollar, interest and country risk fall) and already changing the mood for the return of investments to the country. The honeymoon started well. This phenomenon of the rise of the right in Brazil is not an isolated fact, no. In fact, we are "tagging along" forces that explain BREXIT, Donald Trump and, more recently, the direction Italy chose, among others. Fundamentally with different reasons, but with several points in common, Brazil will be an important "player" in this new political-economic world board, especially in Latin America. The new order is not always well received, and sometimes rejected with vigor. There are many interests to be opposed, and the very change itself carries insecurities and breakdowns of a diverse set of privileges. For this reason, and by evaluating the predecessor examples, the horizon does not show an easy path. Policy planning and steadiness must be strong, cohesive, and fine-tuned. Executive power can do a lot but has limits. Counting on Congress and convincing it of the needs of the country that economists and other technicians will present will not be an easy task, but combining strategies and capacity for political coordination, at variance past experience, will be fundamental. Thus, the quote recently remembered by the economist Eduardo Giannetti that opens this Commentary properly reflects the moment that we live: "Economists can be more naïve about politics than the politicians about the economy". Overseas, difficulties marked the month, especially for investors. World stocks suffered the largest monthly decline in six years, although the fundamentals appear not to have substantially changed in order to justify the movement. Two major economies corroborate this interpretation: US and China. In the US, the economy grows, unemployment is at 3.7% and wages are on the rise... all in the midst of a "complacent" monetary policy by the FED. In China, PBoC failed to further inject capital by credit line for the medium term, but did so in a permanent line, in addition to reducing reserve requirements and volume of commercial banks' reserves. Politically speaking, October did not fall short. The deadline for a reasonable BREXIT agreement is fast approaching and Theresa May's strategy seems to be rejected by almost everyone: the EU, Labor Party and many in the Conservative party. Russia has sent a delegation to Venezuela under the pretext of assisting in a plan against the total collapse of the country's economy... perhaps a response to the US on its ideas about Cuba, Nicaragua and Venezuela. After some time, North Korea again threatens to resume the development of nuclear weapons should the United States fail to fulfill its promise to withdraw its economic sanctions. Last but not least, we now have a migrant caravan heading to the US... a humanitarian crisis with no possibility of a satisfactory outcome for latinos... and in the meantime the so-called American Midterm Elections... quite a "fuel" to boost rhetoric on both sides. In this environment, US Treasuries closed the month at 3.1435%. The S&P varied -6.94%, NIKKEI closed at -9.12%, DAX at -6.53% and FTSE 100 UK at -5.09%. The Ibovespa ended the month at 87,424 points (10.19%) and the IBrX at 36,009 points (10.42%). Monthly highs for DIF19 at 6.668% and DIF21 at 9.52%. The NTN-B 4 2050 ended the month at 5.196%, and the Dollar (Ptax) at BRL 3.7177. Monthly Commentary – October 2018 Economic Outlook External Balance - Brazil Evolution of Brazil's Trade Balance & Trade Flow (Accum. 12m) 150 600 100 500 50 400 300 - 200 -50 USD USD billions USD USD billions 100 -100 - -150 -100 Current Account Direct investments External Financing Needs Exports Imports Trade Balance Trade Flow Source: Ministry of Industry, Foreign Trade and Services and Central Bank of Brazil | Elaborated by Planner Redwood Economic activity in Brazil will be quite sluggish this year, the same being expected for the unemployment rate. Meanwhile, optimism is gaining strength for 2019 onwards, notably by the promises of Paulo Guedes (future Minister of the Economy) of strong pace in privatizations, some progress in the Pension Reform later this year (or at least use that already voted in the Special Committee of the Chamber - a new Constitutional Amendment would be avoided), fiscal adjustment, reduction of the State, the opening of the economy, among other measures. These signs and measures to be taken "right away", while lacking a structured and connected plan, promote a differentiated environment for expectations. In fact, the above-mentioned structured economic plan will have at least six months to show what it is all about. In general, every government enjoys some period of "trust", a deadline to adjust and start up its administration. Thus, despite the likely hostile opposition, especially in Congress, the renewal in the House of Representatives may be inkling that the latter "understands" the urgent need of reforms to support economic recovery. Apart from naïveté, responsibility must prevail. In addition to the macro- actions, it is not possible to discontinue the ongoing microeconomic reforms and the effective increase in competitiveness, which are fundamental for raising potential output. If in this year we will not see a greater than 1.2% of GDP growth, moving forward on the reforms front will take us closer to our potential growth around 3% already in 2019. The Balance of Payments is robust in several of its items. One of them is the Trade Balance, whose chart above leaves no doubt as to its positive performance. We should close 2018 with almost USD 60 billion in trade surplus - a strong outcome from any perspective. Additionally, our current account deficit is estimated at less than USD 15 billion by 2018, around 0.8% of GDP - very low and easily covered by the USD 67 billion forecast of Foreign Direct Investment (FDI). By 2019, both items may perform well, although a more challenging scenario is not discarded for Current Accounts due to a more troubled external landscape with higher interest rates, slightly lower growth and unfavorable commodity prices. Finally, unfortunately, there is no way to disregard the September Manufacturing Survey, wherein output falls short of a consistent recovery. In any case, it also does not appear to be an indicator of increased pessimism, especially as confidence and the labor market are gradually performing better. The feeling that manufacturing sector is slipping is not uncalled for, but this will also be addressed by the new conservative agenda. 5 Monthly Commentary – October 2018 Fiscal Policy The mantra of "total control of spending" must go on. PLOA 2019 – Main Tax Expenditures (BRL Million) It is no wonder the litany goes beyond mere rhetoric. Expenditures have outpaced revenues for years, and this chronic mismatch, given the nature Others of these earmarked expenses and liabilities assumed over the years all rise 75,154 Preferential "automatically". They now need enhanced control, not only with the 25% Corporate Income Tax (Simples preservation of recent mechanisms such as the Expenditure Cap, but also Nacional) with new attitudes to break the inertia and modus operandi we have 87,253 witnessed thus far. 28% Labor Employee If tackling expenses is the mantra, the improvement in tax collection also Benefits 12,538 can not be forgotten. There is no argument here for increasing the tax 4% burden, because it is already around 33%, an unfairly high level for our economic standards. In fact, our tax burden is equivalent to that of several Tax Exemptions – Legal Persons Tax Exemptions - developed countries, and we rank 14th in the world.

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