Brazil: A Stock Picker's Market

Brazil's Positive Outlook

On Friday, February 19, 2021, President Jair Bolsonaro named a former military general to lead the state-controlled petroleum corporation Petrobras. The market respected prior management, and investors applauded the Government’s past willingness to back qualified leaders in state-owned enterprises (SOEs), a large change from previous administrations. The surprising move stemmed from disagreements between the President and Petrobras management in regards to fuel policies. The action signals a shift in the President’s policies as the administration moves from orthodoxy to populism. Though we see the recent news as a challenge for Petrobras and other SOEs, Brazil’s recent underperformance could create an attractive landscape for stock pickers.

graph1-Brazil2021.jpgAfter passing an ambitious pension reform program in 2019, Brazil began making progress towards fiscal stability, which was interrupted by the Covid-19 pandemic in 2020. As a response to the spread of Covid-19, the Government enacted a BRL750 billion fiscal package that included loosening fiscal targets, salary allowances, and the relaxation of labor laws. Despite this setback to fiscal austerity, market-friendly government allies successfully gained power in the recent congressional elections. Brazil’s Congress elected two candidates backed by President Jair Bolsonaro to head the Senate and lower house. The consolidating control of the Bolsonaro government should increase the odds for Finance Minister Guedes to pass his reform plans.

Congress approved new legislation granting autonomy to the Central Bank within two weeks of the recent elections, a positive indicator for further reforms. Other key goals of this agenda include:

  • Maintaining the spending cap
  • Administrative reforms
  • Tax reforms
  • De-earmarking government expenses
  • Continuing to balance fiscal austerity with necessary Covid-19 relief measures

Covid-19 Recovery

The second wave of Covid-19 appears to be having a smaller economic impact than the first. Looking at key economic indicators like consumer confidence, inventory levels, and manufacturing numbers, it appears that economic activity continued to improve through the 4th quarter of 2020 and remained stable through January. Despite Covid-19 lock-down measures throughout 2020, including the second lock-down in key metropolitan regions in December, Brazil reported job growth for the year, creating a net of 142,690 formal jobs.

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In terms of the vaccine roll-out, Brazil has significant experience getting through disease outbreaks. Along with an extensive public health system, Brazil boasts a strong logistical capacity to distribute its vaccines. We believe the country is likely to have its above 60-year-old population vaccinated by June. The vaccination program will allow authorities to continue lifting activity restrictions which will likely further expedite the economic recovery.

Brazil's Attractive Backdrop

Several other market trends should bolster Brazil’s market performance. Brazil’s economy will likely benefit from the recent rise in oil, iron ore, and other commodity prices. Additionally, a weaker US Dollar (USD) environment should be a tailwind, as a weak dollar translates into higher commodity prices, reduces balance sheet pressure, and improves purchasing power.
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Brazil’s key rate still stands at 2%, which is down 1,225 basis points since November 2016. Not only have we seen a dip in interest expenses, but this has also led to more opportunities for borrowing, capital expenditure, and consumption.  The low rate has created a supportive backdrop for local equity investors, as multi-asset strategies can no longer benefit from high rates in fixed income and cash products. In 2020 alone, more than 50 deals came out of Brazil. Deeper capital markets continue to create larger opportunities for equity investors.

Though most of the market has suffered due to the recent Petrobras news, we still see many attractive business models operating in Brazil. A result of lock-down measures has been the acceleration of technology adoption in Brazil.  These positive industry trends could support additional sector outperformance, in-line with global markets, and increase technology representation among Brazilian indices. Additionally, various other companies will likely benefit from easing lock-down restrictions, regardless of government interactions with SOEs.

Looking Forward

We expect near-term volatility within the Brazilian market and continue to seek opportunities where prices dislocate from fundamentals. Recent Brazilian Real (BRL) weakness could push inflation to the upside, putting pressure on the Central Bank to take a hawkish tone. If the monetary policy committee begins to slowly increase interest rates into the second half of the year, we think this could counterintuitively be seen as a positive. The Financials sector makes up more than 25% of MSCI Brazil index, which should benefit from higher rates. Higher yields combined with fiscal austerity may also lead to more flows into the country, which will support the BRL. This is especially true if increasing rates come from a position of strength as the country responds to economic normalization and growth.

The situation in Brazil remains fluid. The Government and SOEs may continue to dominate headlines; however, if the USD proceeds to weaken, commodity prices remain stable, and Finance Minister Guedes maintains the path for reforms, then the recent volatility could create attractive opportunities for stock pickers.​​​​​​​


DEFINITIONS

MSCI Brazil Index is designed to measure the performance of the large and mid-cap segments of the Brazilian market.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.

Return on equity (ROE) is a measure of financial performance calculated by dividing a company’s annual return (net income) by the value of its total shareholders’ equity, expressed as a percentage.

The views and information discussed in this brochure are subject to change and may not reflect the current views of the writer(s). The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation.

Past performance is no guarantee of future results.

Investment Considerations — There can be no guarantee that any strategy (risk management or otherwise) will be successful. All investing involves risk, including the potential of loss of principal.

Emerging Markets Risk — The risks of foreign investments are typically greater in less developed countries, which are sometimes referred to as emerging markets. For example, political, legal and economic structures in these country may be changing rapidly, which can cause instability and greater risk of loss. These countries are also more likely to experience higher levels of inflation, deflation or currency devaluation, which could hurt their economies and securities markets. For these and other reasons, investments in emerging markets are often considered speculative. Similarly, investors are also subject to foreign securities risks including, but not limited to, the fact that foreign investments may be subject to different and in some circumstances less stringent regulatory and disclosure standards than U.S. investments.

Market Disruption and Geopolitical Risk — Geopolitical and other events, including war, terrorism, economic uncertainty, trade disputes, natural and environmental disasters, systemic market dislocations, public health crises and related geopolitical events have led, and in the future may lead, to increased market volatility, which may disrupt U.S. and world economies and markets and may have significant adverse direct or indirect effects on the value of a Fund and its investments.