The race to become president of the world’s fourth largest democracy – Brazil – concluded on 30 October. Centre-left candidate and former President, Luiz Inacio Lula da Silva (50.9%), narrowly beat the incumbent, Jair Bolsonaro (49.1%), to a new four-year term.
After months of uncertainty in the run-up to the elections, we see the outcome as positive for market sentiment in that Lula’s narrow win will likely temper his administration’s plans to increase fiscal spending, as will the shift of Congress towards centre-right control.
The next catalyst for the market will likely be the composition of the new government, particularly the appointment of the next finance minister.
Politics have a big influence on Brazil’s equity market performance, but away from the ballot box, there are three main drivers that have helped Brazilian equities outperform other emerging markets this year, and which we think should continue in the short term:
- Peak in the central bank rate hiking cycle
Unlike most other economies around the globe, inflation has peaked in Brazil. This has allowed the central bank to put its rate hiking cycle on hold. Cumulatively, rates have risen 1175bps from last year to 13.75% currently. The forward curve is now suggesting the central bank will start to cut rates in the second half of 2023, providing a positive potential catalyst for equity markets.
- Recovery in earnings growth
The earnings cycle for the MSCI Brazil Index troughed at the beginning of the year and has since recovered nearly 20% (in USD). Commodity sectors led the initial recovery, which has now broadened to domestic consumer-facing sectors, such as financials and retailers. The 3Q 2022 results season has so far surprised positively and suggests earnings momentum will continue.
- Attractive valuations
Year-to-date, the MSCI Brazil Index has returned 14% (USD, as of 2 November), outperforming the MSCI Emerging Markets Index by 42%. Despite this outperformance, the MSCI Brazil has actually de-rated on a P/E basis as earnings estimates have risen even more. As a result, the index is trading more than one standard deviation cheap (6.7x) to its five-year average forward P/E (10.7x).
Brazil is currently in a virtuous cycle – inflation is decelerating, commodity prices remain robust, earnings are recovering, and political uncertainty has been reduced. We are positive on consumer-facing sectors, which stand to benefit from a potential increase in government support towards lower-income groups and a potential easing in the monetary cycle.
That being said, we remain attuned to potential risks, namely a sustained correction in commodity prices as well as a bigger-than-expected deterioration in fiscal balances. But for the moment, we think the momentum in Brazilian equities has room to continue.
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