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Brazil Remains Priced for Perfection in the Eyes of Investors

01/12/2018 - 12h09



Last month, Brazilian clown and congressman Tiririca surprised people by suddenly announcing that after seven years in office, he would not run for re-election.

"I'm disappointed with Brazilian politics," a saddened Tiririca said. Brazil's political class, apparently, was too much of a joke even for a clown to bear.

His words capture a general public mood of disillusionment as Latin America's largest economy prepares for what may be its most unpredictable elections in memory in October.

Yet investors seem to be heading in the opposite direction, betting that the elections will produce a new president who will maintain the country's recent reform drive or at least will not be so bad as to justify Tiririca's clownish anguish.

The Bovespa index set a record intraday high of 79,414 this week, capping a stream of gains, driven by optimism over Brazil's emergence from a brutal recession.

A risk-on sentiment is spurring emerging market currencies, with the Brazilian real strengthening to R$3.23 a dollar, appreciating 2.3 per cent this month.

To analysts, the drivers behind such a boon are the fair global winds and optimism that the election, while wildly unpredictable in terms of which candidate will win, would not produce any ugly surprises on the economic front, as there is no money to fund some of the populist promises that afflicted Brazil's recent past.

"This may be an uncertain election but without reason for extreme volatility," said Zeina Latif, chief economist at XP Investimentos in São Paulo.

"There is no space for a populist discourse - the money is over." XP forecasts the Bovespa could exceed 89,000 points at the end of 2018 - a 16 per cent rise from where the market closed in 2017.

David Beker at Bank of America Merrill Lynch expects a 21 per cent earnings growth in US dollar terms this year for listed companies in Brazil as the economy derives some support with interest rates at a record low of 7 per cent, coupled with inflation closing 2017 at 2.95 per cent, down from 6.29 per cent at the end of 2016.

Confidence has also been on the rise for Petrobras, a bellwether stock, which has rebounded following a $2.95bn settlement this month to end a class-action lawsuit in the US between the state-owned oil company and large investors over losses caused by a giant corruption scandal. 

Brazil was one of the top performers in emerging markets in 2017.

But sentiment was briefly rattled after Michel Temer, the unpopular president, failed to pass an overhaul of the country's generous pension system, which is seen as crucial to restore fiscal health. Congress is expected to vote on pension reform next month.

"Slowly but steadily the Brazilian economy has been moving towards a better macro equilibrium, but slow progress towards fiscal consolidation could potentially jeopardise the recently achieved gains in macroeconomic performance and asset prices," warns Goldman Sachs economist Alberto Ramos.

"While not high, there is still some chance that Congress manages to approve a minimalist social security reform during the first quarter," he adds.

Even if Mr Temer's pensions overhaul is diluted, as it has already been, any reform at all would count as an improvement of the steadily worsening public finances under his leftist impeached predecessor Dilma Rousseff.

This would add reassurance that Brazil will honour its debts.

Analysts warn that the election of a populist could trigger a stress scenario - and until January 24, that remains a big question mark.

That day a Brazilian federal court is set to hear an appeal by former president Luiz Inácio da Silva, the country's most popular politician, against a criminal conviction for corruption.

If the court upholds the conviction, his chances of contesting the election will be severely damaged. If it overturns the conviction, the former unionist firebrand who ruled Brazil between 2003 and 2010 will be able to participate, reigniting the populist vote and trouncing market expectations. He is leading the vote in opinion polls.

Many caution it is too early to draw a firm conclusion. Brazilian bonds offer a testimony of the optimism among investors that voters, soured by corruption scandals, will not vote for old faces such as Mr Lula da Silva.

The 10-year dollar-denominated benchmark yields 4.45 per cent, down from 5.5 per cent at the start of last year. 

Foreign flows to Brazil's stock market were positive by $80m in the first week of January, according to an analysis of data by Itaú economist Mario Mesquita. 

Twice Tiririca was elected to Congress under the slogan "It can't get any worse". At last investors seem to agree with him that the worst is over.

Copyright The Financial Times Limited 2018

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