Brazil’s presidential elections proved to be a minor event for markets. For the first time since Brazil returned to democracy in 1985, the candidates were in agreement on the need for responsible monetary and fiscal policies so there was much less at stake for investors.
With the economy exper-iencing unprecedented stability, there was not much support for radical change. As Lula da Silva begins his second and final term in office, markets can expect more of the same policies he followed in his first term.
The combination of strong growth in real wages and expansion of the Bolsa Família subsidy programme, which gives monthly cash payments to some 12 million poor households, cemented Lula’s popularity among the poor. The inability to criticise the government’s economic record proved a fatal handicap for the candidacy of outgoing Sao Paulo state governor Geraldo Alckmin, despite a corruption scandal involving Lula’s party.
There is some concern that Lula’s second term will be dominated by ideologues from the left wing of his party but this does not seem likely, given that Lula is a pragmatic leader who is well aware that his re-election is largely due to the economic stability of his first term and who has little incentive to deviate from market-friendly economic policies. To strengthen his support in Congress, it is likely that Lula will concede positions in his cabinet to his coalition partner, the centrist Partido do Movimento Democrático Brasileiro, providing further support for a pragmatic second term.
The domestic economy has been accelerating, fuelled by strong consumer demand as wages rise, interest rates fall and banks step up lending. This should help corporate earnings to grow at a healthy pace although the economy is expected to grow a mere 3 per cent this year. The economy is well positioned to weather any global volatility, with the government now a net external creditor and the current account expected to post a small surplus this year and next.
The Brazilian market did not escape the correction of May and June, which saw the Sao Paulo Stock Exchange fall from 41,979 to a low of 32,848 before rebounding to the current 39,262. Valuations remain attractive at only nine times consensus earnings for the next 12 months – the lowest price to earnings’ multiple of any emerging market, according to Bear Stearns.
International investors are overweight in Brazil but local investors have long preferred to invest in fixed income due to high interest rates. As rates have fallen from 19.75 per cent to 13.75 per cent over the last 15 months, with inflation expected to be 4.2 per cent over the next 12 months, local investors are expected to increase their exposure to equities. Lower rates should also provide a further boost to domestic consumption and lead to faster GDP growth.
The Brazilian market is roughly evenly divided between global commodity players and domestic stocks. We are positive on the outlook for the two commodity heavyweights – fast growing oil company Petrobrás and iron ore producer CVRD – but expect better earnings growth in the domestic sector. We particularly like stocks in the banking, utilities, housing and retail sectors.
Banco Itaú, perhaps the most sophisticated Brazilian bank, is best positioned to make the transition from the traditional banking model of betting on market volatility, which in a stable macro-economic environment is no longer viable, to the more classic banking business driven by lending. We expect it to continue generating a return on equity in excess of 30 per cent over the next few years.
We like clothing retailer Lojas Renner, which is benefiting from stronger consumer spending power, and also favour Energías do Brasil, which is increasing generating capability while rising energy demand is leading to higher electricity tariffs and the regulatory environment is becoming more investor-friendly.
Urban Larson is director for emerging equities at F&C