Brazil’s stock market is in a “honeymoon period” following the victory of Jair Bolsonaro in the country’s Presidential election run-off on Sunday, according to experts. But how long this will continue is uncertain.
While liberal voters worry about the social impact of the divisive far-right candidate securing power, he is widely seen as market-friendly, giving risk assets a boost.
After a month-long losing streak, during which the Brazilian currency fell 13.5% from a five-year high, the real has seen a modest rebound since the weekend.
The Ibovespa, the Sao Paolo stock market, is also up since the election. Since bottoming out in June to less than 70,000, it’s now up almost a quarter to 86,815.
Bond markets, meanwhile, had been selling off for the best part of the last two years, hitting a yield of 12.4% in September. That number is now 10%, meaning bond values have recovered somewhat.
Bolsonaro ran on an economic reform agenda, which includes cutting and simplifying taxes, privatising state-owned enterprises and reforming the pension system.
Bolsonaro’s credentials in this space are “mixed at best”, according to Verena Wachnitz, portfolio manager of the T. Rowe Price Latin American Equity fund.
But he does have a strong team on which to draw upon, including the Chicago-educated economist Paulo Guedes, who will head his economic team. “Bolsonaro seems happy to let this liberal economist run the economic agenda,” says Wachnitz.
Guedes’ pensions reforms, in particular, have the potential to be a game changer for Brazil’s long-term debt sustainability, says Delphine Arrighi, manager of the Merian Emerging Market Debt fund.
Wachnitz notes that much of the heavy lifting regarding reforms has already been taken care of by the outgoing administration of Michel Temer.
In fact, she adds, while full implementation of his reforms would be bullish, that’s not necessary for markets to continue their recovery. “Maintaining the spending cap, while delivering a slightly-diluted pension reform, are achievable outcomes and would go a long way in lifting business confidence and solidifying the ongoing economic recovery.”
Still, there are some key milestones ahead that need to be completed. The first that the market will now be focusing on, says Arrighi, is his ability to form a coalition for reform, against a backdrop of a “notoriously fragmented congress”.
Reform Won’t Be Easy
Kim Catechis, manager of the Martin Currie Global Emerging Markets fund, thinks there will be strong opposition to the reform plans.
“In an already polarised country, unions will challenge reforms and privatisation, while any anti-corruption drive will result in a period of policy stagnation, as bureaucrats will hesitate to sign off in case they end up in jail. The capital markets do not have the patience for this to come through,” he says.
On the equities side, Wachnitz sees scope for earnings growth amidst any improvements in economic growth, allied to low inflation and low interest rates. “This is especially true for domestically-exposed firms in the financials and consumer sectors. Valuations are still attractive versus long-term historical averages, on still cyclically-low earnings.”
Chetan Sehgal, manager of Templeton Emerging Markets Investment Trust (TEM), agrees that Brazil has plenty of upside, but next year will be key – “it’s all about implementation,” he says.
On the bond side, despite recent upward moves Arrighi does not think reforms are have been priced in fully. She says: “We continue to see value in the curve, given the lack of inflationary pressures and potential for significant fiscal turnaround.
“The external environment may remain challenging for emerging markets as a whole but, given the scarcity of improving macro stories at the moment, Brazil could continue to stand out.”
But it’s not all positive. Fidelity’s Paul Greer has some worries and says he’s bearish on the fundamentals in the country over the medium term.
“We remain concerned about the trajectory of Brazil’s fiscal balances. We don’t believe in the likelihood of meaningful fiscal reform, especially pension, social security and tax reform, which is ultimately what Brazil needs to help keep further ratings downgrades at bay from the credit agencies in 2019.
“We feel the controversy and divisiveness of Bolsonaro’s political agenda, along with his high rejection rates, will prevent him from passing the necessary bills in congress.
“We expect Brazil to maintain its sub potential growth, and for inflation to push higher in 2019, which will prompt the central bank to hike rates.”
