No need for investor jitters over indecisive Brazil election outcome – 1777

5th October 2010

The first round of the election on Sunday was widely expected to result in victory for Dilma Rousseff of the Workers Party and the preferred candidate of incumbent President Lula.

Having failed to win outright though, a second round will now ensue at the end of the month, with Rouseff up against Jose Serra of the Social Democrats Party, as the Latin American Herald Tribune reports.

With Brazil one of the major targets for investors looking to benefit from upside among the emerging countries, the indecisive first round might be the cause of some jitters.

Philip Poole, global head of investment strategy at HSBC Global Asset Management, however, strikes a reassuring note, pointing out that both candidates are firmly committed to continuing with policies that have helped transform a Brazil riven by political and economic instability into a leading light in the emerging market universe. Not for nothing is it accorded a place in the BRIC (Brazil, Russia, India, China) bloc.

More of the same whoever wins

Investors therefore should expect whoever wins to continue with Brazil's commitment to a floating exchange rate regime; fiscal responsibility in law; and inflation targeting.

The winner can hardly do otherwise in any case: it is hard to argue against policies that are accruing an impressive 7% year-on-year growth after the lost decades of economic mismanagement and military rule.

This interesting blog also argues that Brazil's future is mapped out whoever wins the election.

Poole cites the Brazilian markets "remarkably calm" behaviour in the run up to the election as a demonstration of just how far Brazil has come politically and economically over the last ten years.  Compare that reaction to 2002 when the country's Bovespa equity index and local currency slumped 40% on panic ahead of the Presidential elections held that year.

Add in central bank independence and a banking system purged of excess leverage and Poole's argument that Brazil represents a ‘strong investment opportunity', and will continue to do so, becomes all the more powerful.

While Brazil's growth is likely to moderate to 4.5% to 5% over the next few years, that is still pretty good and should be delivered against a backdrop of easing inflationary pressures.  Near-term though some economists polled by Bloomberg expect inflation to edge ahead.

Heavy rate hikes not expected

Poole's colleague, Jose Cuervo, co-manager of the US$2bn HSBC GIF Brazil Equity Fund says: "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," says Poole.

Cuervo believes Brazil is in an economic and investment "sweet spot", with the domestic economy growing fast but not so fast as to trigger uncontrollable inflation and interest rates low.

Furthermore, upgrades for Brazilian equities are in the pipeline. Forecasts for earnings per share growth for the MSCI Brazil Index, which is heavy in energy, materials and financial stocks, stand at 28.6% for 2010 and 25.6% for 2011.

The Brazilian market is also cheaper than its BRIC peers, trading as it does on a forward multiple of 11.6 compared with 13.8 for China and 18.7 for India.

Risk factors

While there are risks associated with investing in Brazil, Poole says these are mostly external. "Brazil would not, for instance, be immune to a global ‘double dip' recession, though this is not HSBC's expected outcome."

Another concern is that like many other commodity exporters Brazil is exposed to China. The slowdown in China is part of the reason for recent global jitters but HSBC's view is that China is slowing not melting down and the recent data is supporting this, he says.

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