Calm run up to Brazil general election strengthens investment case, experts believe

Written by Ray Clancy

Thursday, 23 September 2010 09:18

The Brazilian markets’ remarkably calm behaviour leading up to the October Presidential election demonstrates the success of the political and economic improvements over the past decade and strengthens the investment case for this country, according to a new report.

Perceived political risk in the run up to Brazilian presidential elections has historically destabilised Brazilian assets and the currency. For example, in 2002 the Bovespa equity index and the local currency both plunged by more than 40% as investors panicked about the possible outcome.

But this time around, with the election approaching, there is no such sign of concern, let alone panic, according to Philip Poole, global head of macro and investment strategy at HSBC Global Asset Management.

He said political and economic improvements over the past decade, together with de facto central bank independence, have fundamentally changed the investment landscape in Brazil. This should give investors further confidence that although Brazil represents a strong investment opportunity, the level of associated risk has been substantially reduced.

A further example is Brazil’s relatively ‘comfortable’ time during the global economic crisis, reflecting a sound economic management and a banking system that had already been purged of excess leverage, Poole said.

Jose Cuervo, co-manager of the US$2 billion HSBC GIF Brazil Equity fund, said the investment case looks sound. Brazil is experiencing strong economic growth this year which should top 7%, then moderating to 4.5 to 5.0% over the next few years. ‘Concerns over inflation have been easing recently as the year on year comparisons begin to ease. Although the tightening on this monetary cycle is not over, we do not expect interest rates to be hiked materially over the coming months as inflation is not rising out of control,’ he said.

"Brazil is therefore in an economic and investment sweet spot, where the domestic economy is growing fast, but not so fast that inflation is getting out of control. The global environment is weak, but not so weak that it is affecting Brazil, yet it is keeping interest rates in Brazil low. This is a potentially ideal economic and investment environment,’ he added.

Cuervo explained that in addition to strong GDP growth, Brazilian equities should continue to benefit from earnings upgrades. Earnings per share (EPS) growth for the MSCI Brazil index stands at 28.6% for 2010 and 25.6% for 2011.

Meanwhile, the market appears relatively cheap compared to BRIC peers, trading on a 2010 forward multiple of 11.6x compared to 13.8x for China and 18.7x for India.

Within the equity markets, Cuervo said domestic stocks are particularly appealing with support from robust consumption, favourable demographics, a buoyant labour market and rising real wages. Commodity stocks should also eventually benefit when it becomes clear that hard landing concerns over China are overdone.

Poole believes there also remains value in Brazilian fixed income, as part of a broader positive trend in emerging debt. Yields are likely to stay very low across external and local debt markets with a general compression of spreads in line with the rest of the asset class. Hew said there are still risks with Brazil, but these are mostly external.