Investment managers discuss Brazil’s economic landscape and potential opportunities a year after President Luiz Inácio Lula da Silva's last election victory, viewing it as a bright spot in the global equity markets.
One year ago, shortly after the election of Luiz Inácio Lula da Silva as Brazil’s next president, US-based investment manager Franklin Templeton said that there was ground for optimism in Brazilian equities while markets considered the prospects of more left-wing policies with a healthy dose of skepticism.
“Lula is a known quantity in Brazil,” and he inherited “an economy on solid footing with significant long-term potential” were some of the conclusions Frankin Templeton noted then.
Year-to-date, both the FTSE Brazil 30/18 Capped Net Index and the FTSE Brazil Index outperformed broad emerging markets by about 11 percentage points at 9.4 per cent and 10.3 per cent, respectively, versus 1.7 per cent as of late October, the firm continued. This has come amid expectedly significant volatility that saw Brazil equities slip 10 per cent in mid-March and rise again by nearly a quarter at the end of July.
Brazil’s central bank has begun to cut rates – ahead of many emerging market and virtually all developed market peers. Consensus forecasts for the end of this year assume another 100 basis-point cut, the firm added.
Franklin Templeton’s Marcus Weyerer and Dina Ting anticipate ample room for the Banco Central do Brasil (BCB) to maneuver in 2024, if inflation maintains its downward trajectory and the effects from certain climatic events, such as El Niño, can be contained.
“Brazil kicked off some of the earliest and most aggressive rate hikes globally, an approach that is now beginning to pay off,” they said. While inflation, as measured by the consumer price index (CPI), remains above target, expectations for 2023 and 2024 currently sit at 5.1 per cent and 4 per cent, respectively, they added. This is a far cry from the near double digits witnessed over the course of 2022.
At the same time, the country’s unemployment rate has reached a nine-year low, while consumer confidence has eclipsed pre-pandemic levels and is at its highest point since 2014.
Given all that, they view Brazilian equities as substantially undervalued, with price-to-earnings (P/E) ratios for the last 12 months (LTM P/Es) in the mid- to high-single digits, constituting a material discount to both emerging markets and developed markets.
On geopolitical risk
There is likely to be some domestic political risk, mainly debt-related, priced into Brazil’s valuations, but so far, Lula has stuck to the pragmatic approach they anticipated of him, and market fears over any ideologically driven spending sprees have not materialized. Furthermore, the high China exposure of broad emerging market indexes also means that these indexes might already incorporate some geopolitical risk component, they said.
With a strong labor market, robust consumer confidence, and the prospect of further rate cuts on the back of falling inflation, Franklin Templeton views Brazil, the world’s eighth largest oil producer, as a bright spot in the global equity markets. “Investors who share our analysis regarding the long-term prospects of Latin America’s largest economy may now find an attractive entry point – perhaps with the added potential to witness a repricing of valuations to pre-Covid levels relative to the price of oil,” Weyerer and Ting said.
Chetan Sehgal, lead portfolio manager of Templeton Emerging Markets Investment Trust (TEMIT) and senior managing director at Franklin Templeton, also recently highlighted in an interview with this news service how Brazil has recovered recently. He is quite optimistic about the outlook: “There was a change in government in Brazil. Once the tax reform takes place in Brazil, the outlook will be more positive.”
Senior macro strategist Homin Lee at Swiss global wealth and asset manager Lombard Odier is focusing on a positive outlook in Brazil too. The country has positively surprised investors with bumper agricultural harvests that have more than doubled in the first quarter of 2023 compared with the previous three months, improving economic growth, domestic reforms, falling inflation and interest rate cuts, he said.
Higher expectations for Brazil’s 2023 growth and improving fiscal prospects have supported the currency this year. The Brazilian real has resisted the dollar’s recovery against other major currencies, Lee continued. Lombard Odier takes a selective approach to emerging market allocations, and consequently maintains an overweight position in Brazilian local currency debt in client portfolios and the Brazilian real. See more here.
Mark Williams, co-portfolio manager of the Emerging Markets Dividend Growth Fund at Somerset Capital Management, also believes that Brazil is a promising market.
“We have been surprised by how long interest rates have been held high. Now that inflation is falling, the prospects of continued rate cuts – which will provide an avenue for both the economy and Brazilian equities to recover – is improving,” he told this news service. “Over recent weeks, the Brazilian Central Bank has announced three 50 bps cuts from 13.75 per cent to the current 12.25 per cent, which was followed by a market rally shortly afterwards.”
“Within our Brazilian holdings in the Somerset Emerging Markets Dividend Growth Fund, we hold oil exposure (Petro Rio), internet services (Locaweb) and a department store operator (Lojas Renner), which all benefit from falling rates either indirectly via improved domestic consumption or directly through lower debt costs,” he added.