EQUITIES 6 minutes to read

What does Bolsonaro's win mean for Brazilian stocks?

Peter Garnry

Head of Equity Strategy

Summary:  Investor optimism is high in the wake of right-wing politician Jair Bolsonaro's Brazilian election win, but Brazilian shares are not exactly cheap, and the country still faces severe structural issues.


Investors are showing significant optimism on Brazilian equities following Jair Bolsonaro’s election victory in Brazil. Political commentators have explored the potential for closer links between the US and Brazil and away from China as the latter has groomed relationships with Brazil to preserve a steady supply of key raw materials for China’s economic boom.

Bolsonaro's right-wing stances, complete with counsel from University of Chicago-trained financial advisor Paolo Guedes, could be seen as making him a natural ally to the pro-business US president. The long-term disconnect between politics and equity markets, however, is often huge and investors should be careful about turning too optimistic on Brazil. The country’s unemployment rate has spiked over the past four years following the collapse in commodity prices, stronger USD and higher interest rates.

Brazil is still one of those countries that played its hand very badly during the commodities super-cycle. But even more importantly, the equity market is not cheap enough to warrant risk-taking by foreign investors.
Enlarge
Brazilian equities are not outright expensive as they were in the last year before the Great Financial Crisis in 2008, but they are certainly not cheap as corporate profitability has plummeted during the recent weak macro years. In terms of valuation we are observing 0.5 standard deviations of 'expensiveness' across our preferred nine valuation metrics. 

But how important is that for future returns?
Enlarge
Based on the short history of credible data on Brazilian equities, there is a clear link between valuation and their subsequent realised real return, as expected. Based on the current valuation, the expected 10-year annualised real return is around 3% (with a wide confidence band).

That’s attractive on the surface but these numbers are in BRL so the attractiveness is only valid for domestic investors. For foreign investors, the opportunity looks less attractive. The current average inflation rate is around 4.5% and if it stays at that level over the coming years, then the expected nominal return in BRL is around 7.5%.

Unfortunately, foreign investors cannot capture this expected return. For a European investor there are two options. You could invest in Brazilian equities and assume the currency risk in EURBRL or, alternatively, invest in Brazilian equities and hedge the currency risk.

The current Brazilian one-year interest rate is around 7% and the one-year euro area rate on a GDP-weighted basis is 0.6%. When a European investor hedges the currency risk, the attractive local return disappears.
Enlarge
Ultimately, Bolsonaro's victory is not enough to change our view. The opportunity is interesting for local investors, but for many foreign investors the Brazilian equity market is not attractive enough if one does not want to assume the currency risk. 

For more on Bolsonaro and Brazil, see Saxo Bank Head of Forex Strategy John Hardy's take on the Brazilian real.

You can access both of our platforms from a single Saxo account.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)