Although these unfortunate events of violence may make Brazilian assets volatile in the near term, CIO expects any impact to be short-lived. (ddp)

However, by Sunday evening, Brazilian authorities had detained a large number of protesters and regained control of the sites. President Luiz Inácio Lula da Silva has signed an executive decree allowing federal intervention to ensure public security in Brasília.

The rioting has drawn condemnation from a very diverse set of political and media actors in the country. At the margin, the unruly protests look likely to rally society against violent far-right movements, and to strengthen the legitimacy of Lula’s administration.

From an investment perspective, although these unfortunate events of violence may make Brazilian assets volatile in the near term, we expect any impact to be short-lived. Once the dust settles, investor focus will likely return to the economic policy initiatives of Lula’s administration.

However, contrary to our expectations, the recently inaugurated administration has cast economic policy pragmatism aside so far. Its plans on how to address Brazil’s fiscal challenges and manage state-owned enterprises have been disappointing. Congress has also failed to act as a balancing force in these areas, in our view. We have therefore reduced our enthusiasm for Brazilian assets lately.

Regarding the Brazilian real, our models indicate that the currency has a fair value of around 5.25 against the US dollar, not far from current levels. Nonetheless, we forecast the BRL will trade closer to 5.5 against the greenback in the coming quarters, reflecting the prevailing high levels of economic policy uncertainty.

As for fixed income, we believe US dollar-denominated Brazilian sovereign bonds are now trading at fair-to-expensive valuations, but we maintain our constructive view on Brazilian corporate debt. Brazilian companies covered by our team include world-class agricultural and mining commodity producers and industry champions with global scale, as well as systemically important logistics operators and financial institutions, many of which could bear higher credit ratings if domiciled in a better-rated underlying sovereign. The risk of government meddling in state-controlled entities may have increased, but the enhancement of corporate governance standards in the aftermath of the Jato scandal should mitigate this risk.

Brazilian equities are trading at very undemanding valuations. MSCI Brazil’s 12-month forward P/E stands below 7x, which is well below historical averages. Brazilian stocks are also trading at a 42% discount to those of emerging markets, which is considerably larger than the 9% average of the past decade. In addition, the asset class stands to benefit from an environment of high commodity prices and relatively low vulnerability to tight global liquidity, in our view. A fragile fiscal and domestic political outlook in the near term will likely continue to weigh on the asset class, however. We therefore expect Brazilian stocks to trade in line with their emerging market peers in the coming months.

Main contributors: Alejo Czerwonko, Ronaldo Patah, Pedro Quintanilla-Dieck, Donald McLauchlan, Xingchen Yu

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

Original report - Brazil: Once the dust settles, market focus will return to Lula’s economic policies, 9 January, 2023.