Brazilian equities face unsettled times
Brazil’s political tensions has reached new heights since justice minister Sergio Moro, resigned last Friday, claiming political interference in the Federal Police.
Key future developments to watch will be Finance Minister Paulo Guedes’s stance on the ‘Pro-Brazil’ plan and his overall relationship with Bolsonaro as well as the outcome of Bolsonaro’s ongoing negotiations with the Centrão political block to bolster his support in Congress. Mayoral elections due to take place in October may trigger additional political noise.
Coming on top of the coronavirus outbreak, the rising political tensions are set to increase the volatility of Brazilian assets. Brazilian equities have been hard hit this year due to a combination of collapsing earnings (-20% in local currency terms), falling valuations (up to -40% at one stage, now back to -20%), and a swift BRL devaluation (-30% vs the US dollar since 1 January). Overall, the Bovespa is down about -52% year to date in USD terms, which makes it the worst-performing market across the EM space. On the plus side, the Central Bank of Brazil (BCB) has been active in ensuring accommodative monetary conditions, cutting the Selic rate by a further 50bps (to 3.75%) in March after five previous cuts worth a cumulative 225 bps since mid-2019.
However, the Bovespa is only back to its 2018 levels (in other words, before the dramatic rally last year), which is justified given uncertainties on the sustainability of Brazil’s current economic trajectory. Additionally, the contraction in earnings appears commensurate with the magnitude of the economic downturn to come, which will likely be worse than in 2015! We do see a risk of further earnings downgrades, notably in the financial sector, which is the market’s largest component.
As far as economic growth and political stability are concerned, the risks are currently tilted to the downside, and the virus contagion appears less under control than in other Latin American countries. Paradoxically, too large a covid-19 stimulus package would not necessarily be positive news given market concerns around the sustainability of Brazil’s debt dynamics.
We would therefore refrain from adding Brazilian equity exposure at this stage in the absence of an obvious catalyst, such as a recovery in commodity prices (which would indicate a robust rebound in economic activity at a global level) or abating domestic political tensions. Our year-end target for the Bovespa is BRL 85,000 (a modest ~8% upside from current levels), reflecting our neutral stance (50% probability).