No, we don’t think so. While there may be higher-than-typical market volatility around the run-off election on October 30, we expect economic issues will be the primary driver of Brazilian equities in the months that follow. On balance, we see these issues as neither overly positive nor negative and recommend that investors maintain Brazilian allocations in line with their policy.
The first-round presidential election results suggest that a government led by Luiz Inácio Lula da Silva may be more centrist than some expected. The politically left-leaning former president topped right-wing incumbent Jair Bolsonaro by just 5 percentage points (ppts) in the first round, and right-leaning parties secured wins that increase their influence in the National Congress. Although Lula remains the favorite to win the presidency, he may be limited in his ability to pass major legislation, particularly with respect to the economic and social justice issues he has championed. Should Lula win, a key concern is whether Bolsonaro accepts defeat, as he has already raised unfounded election fraud concerns.
Markets cheered the first-round outcome. Brazilian equities and the Brazilian real soared 6% and 4%, respectively, the day after the vote. At the same time, reports of a larger-than-expected OPEC+ production cut boosted oil prices, which likely played a role in the strong return. That post-election rally added to Brazil’s standout performance this year. Brazilian equities gained 17% year-to-date in USD terms through last Friday, compared to a 26% decline for global equities. The real appreciated 5% vis-à-vis the US dollar this year, which is a stark outlier given the greenback strengthened against most developed and emerging currencies.
Improved economic activity and an aggressive central bank supported Brazilian markets this year. Booming exports, stronger commodity prices, and a rebound in service sector activity led analysts to revise 2022 GDP forecasts up from 0.8% at the start of 2022 to 2.5% now. These helped the unemployment rate drop to seven-year lows. In addition, the Banco Central do Brasil’s (BCB) decisive action to fight inflation supported the currency. The BCB raised its benchmark Selic rate by nearly 12 ppts over the past 18 months, well ahead of—and more aggressively than—developed peers.
The global economy is on fragile footing, but Brazilian markets may prove resilient to the mounting macro storm. The International Monetary Fund recently announced that their 2023 outlook reflects the weakest global growth profile in the last 20 years, outside of the Global Financial Crisis and COVID-19 pandemic. Emerging markets equities face added external pressures from a stronger US dollar, tightening Federal Reserve policy, and weakening activity in China. But Brazil’s diversified export base limits the impact of China’s slowdown relative to other emerging markets, particularly those in Asia. The country’s exports also stand to benefit from continued metal demand linked to the global energy transition. Finally, the BCB is near the end of its tightening cycle and has significant room to loosen policy should economic conditions deteriorate. In contrast, many Asian central banks accelerated their monetary tightening in the third quarter and drew on FX reserves to support weakening currency values.
Brazil’s performance may be held back by fears over its debt sustainability. Higher commodity prices haven’t translated into the same magnitude of performance as prior cycles, which is partly linked to fiscal and debt concerns wrought by Bolsonaro and COVID-19. As it stands, Brazil has one of the highest public debt-to-GDP ratios among major emerging markets economies and has largely abandoned its fiscal spending rule, which limits growth in outlays to the prior year’s inflation rate. The cyclical growth recovery cushioned public accounts in recent quarters, but this support seems set to erode. And neither presidential candidate is keen on reversing the fiscal expansion enacted by Bolsonaro this year.
We expect that macroeconomic issues will be the key driver of Brazilian equities following the closely watched run-off election later this month. Our outlook for Brazil, in relation to other equity markets, is neutral, given the prevailing balance of macro risks today. Within emerging markets, we prefer a risk-controlled overweight to broad Chinese equities, as current low valuations and easing monetary and fiscal policy support the case for upside potential.