Brazil’s Market Rally Isn’t Over. 4 Stocks to Consider.
Lula’s markets honeymoon is over. But the marriage isn’t annulled yet. Investors are still buying marked-down Brazilian assets, cautiously.
Brazil rocked through 2023 as Luiz Inácio Lula da Silva, starting a third term as the Latin American giant’s president, tilted more pragmatic than left-wing. This year not so much.
The iShares MSCI Brazil exchange-traded fund has shed 15% since early May. The yield on 10-year local-currency bonds has jumped almost two percentage points year to date to more than 12%.
Blame, in part, the global economic weather made in Washington. Investors were counting on Brazil cutting interest rates to single digits this year as the Federal Reserve began to loosen. Instead, the Fed is on hold, and Brazil’s central bank is sticking with 10.5%.
Lula, as the 78-year-old leader is known, has undermined confidence too, though. “It’s almost all domestic factors at play,” says Arif Joshi, co-head of emerging market debt at Lazard Asset Management. “The selloff is completely warranted.”
Projections for Brazil’s primary budget deficit (not including interest costs) have crept up from 0.5% to 0.8% of gross domestic product, Joshi says. The government wants to move the target date for a primary surplus from next year to 2026.
Those might seem like small details compared with budget-busting pre-election spending in, say, India or Mexico. But debt service already eats up nearly 30% of Brazil’s state revenue, compared with 15% for Mexico, says Thierry Larose, portfolio manager for emerging markets local debt at Vontobel Asset Management.
Lula is also bullying the central bank, labeling respected governor Roberto Campos Neto a “political and ideological adversary” after the latest refusal to cut rates further. That’s worrying because Campos Neto’s term ends this year, and Lula appointees will control monetary policy going into 2025.
Nonetheless, Joshi and Larose aren’t exactly fleeing Brazil. Lazard has shifted from overweight to “a more neutral position” in Brazilian debt, Joshi says. Vontobel is adding back after selling off earlier this year.
Brazil’s economic present looks pretty robust. Growth is holding steady at around 2% a year. Unemployment is a relatively low 8%. Campos Neto’s central bank holds a hefty $350 billion in currency reserves.
And 10.5% interest over 4%-ish annual inflation still offers a near-world-beating real interest rate. “I’m hard-pressed to see a further selloff, so you’re getting paid nicely to wait,” Joshi says.
The outlook is tougher for stocks as global investors have soured on the Brazil story, and domestic investors stick with rich fixed-income returns, says Daniel Gewehr, head of Latin American equity strategy at Itau BBA.
Still, the drop in prices is throwing up some deep value plays, he says. Brazilian equities are trading at an average 7.5 times earnings, a quarter less than their historical average.
Gewehr’s top picks include utility Equatorial Energia and port operator Santos Brasil Participacoes, infrastructure powers with long-term financing and reliable revenue streams. He also likes shopping mall giant Multiplan Empreendimentos Imobiliarios and Direcional Engenharia, a low-cost home builder poised to benefit from Lula’s programs to house the poor.
Brazil watchers will be on alert in late July, when the government publishes a review of public sector spending. Northern Hemisphere autumn brings new budget talks, municipal elections, and Lula’s nomination of a new central bank boss.
“Lula has a track record of shifting pragmatically before things get out of control,” Larose comments.
If he doesn’t, things could get ugly.