President Lula will face a divided nation, having won in just the northeast of the country. He failed to emerge ahead in Brazil's north, south, mid-west, and southwest. (ddp)

There has been much speculation that the election results could be contested. But we think this is unlikely. Electoral authorities were very proactivein answering any concerns about the reliability of the electronic ballotsthroughout the campaign. Also, the military audited a sample of the ballotsand reportedly did not find any flaws. Governors, congress members, the judiciary system, the military, the attorney general, and the prosecutor’s officeare all unlikely to support any attempt to disrupt the transition of power. In addition, the most important countries that Brazil maintains diplomatic relationships with have already recognized the electoral results. Groupsclosest to Bolsonaro, such as truck drivers, may stage some protests in the coming days, but it is unlikely these will escalate into an institutional crisis, in our view.

Importantly, Bolsonaro can look ahead to 2026, when the next general election is due. He obtained 58 million votes and will lead the opposition from January 2023 onwards, in a political environment where Congress and local governments are dominated by right-of-center parties, offering him a platform to run again in the future.

A moderate Lula likely

President Lula will face a divided nation, having won in just the northeast of the country. He failed to emerge ahead in Brazil's north, south, mid-west, and southwest. His first challenge will therefore be to soothe national sentiment, as the campaigns have triggered fierce, often polarized debates around major issues. We think Lula will have to bridge the political divide by listening to the other side.

All in, we believe the new government will behave like a moderate center-left one, as Lula has built alliances with key names from the center of the political spectrum, starting with his vice president Geraldo Alckmin. Lula also received support from important economists who worked for the center-left government of former president Fernando Henrique Cardoso. We believe that Lula understands the need for fiscal responsibility, as the downside is high with strong opposition in Congress and given the challenging global liquidity backdrop. He seems likely to appoint a politician from the Worker's Party for the finance minister position, particularly someone who will be able to build a diverse team of moderate economists to implement economic policy.

For more details on what investors should expect of the incoming Lula government, please to our Investing in Brazil report.

Investment implications

Even in the face of possible election-induced volatility, we believe Brazil equities will outperform their emerging market peers over the next 12 to 18 months, driven by high commodity prices, attractive valuations, relatively low vulnerability to tighter global liquidity, and very high dividend yields.

We also maintain a constructive view on the BRL despite the strong USD environment, with a 5.00 forecast against the greenback through the next 12 months. Brazil enjoys an independent central bank, one that is comfortably conducting its monetary policy in an inflationary environment. Policy rates are at 13.75%, and though we think the cycle has peaked, the central bank likely won’t hesitate to hike more if needed. In addition, Brazil’s external accounts are in good health with a modest current account deficit fully funded by FDI, together with sizable external assets in the form of international reserves.

In our local, BRL-denominated tactical asset allocation, we keep nominal bonds and floating-rate bonds at most preferred, and global assets at least preferred. We also keep our neutral stance on inflation-linked bonds, equities, hedge funds, real estate funds, and alternative assets.

Main contributor: Alejo Czerwonko, Ronaldo Patah

Content is a product of the Chief Investment Office (CIO).

Original report - Brazil: Former President Lula wins, 31 October, 2022.