Two candidates endorsed by President Bolsonaro have been elected as leaders of the lower and upper houses of Brazil's Congress. This likely saves Bolsonaro from impeachment (over his handling of the Covid-19 crisis). While a breakdown in relations between the executive and the legislature has been avoided, this election does not significantly increase the likelihood of structural fiscal reforms, which are needed to transform the Brazil investment case into something more than simply a play on commodity prices.
Fragmented Congress
Congress remains very fragmented with the new Congressional leaders' own parties accounting for merely 6.6% (Arthur Lira's Progressistas in the lower house) and 8.6% (Rodrigo Pacheco's Democratas in the upper house).
Fiscal deficit and debt concerns
The risk to fiscal deficit and government debt forecasts remains on the downside. The IMF, in its December 2020 Article IV report, forecast a c6% overall fiscal deficit and c100% debt to GDP ratio (although almost all of this is in local currency) in 2021. The 3.5% of GDP savings it estimates are feasible via fiscal reform – such as reducing public sector pay, tax exemptions, and local government deficits – may remain elusive.
Equities: Vale in Brazil, but India above Brazil
Reform is unlikely to drive the top-down investment case in Brazil, which remains reliant on potentially higher commodity prices and a rotation out of markets like China-Korea-Taiwan (where Technology bias has driven outperformance over the last year to a point where valuations are much more expensive relative to history compared to less Tech-centric parts of EM).
Within Brazil, this means a preference for index heavyweight, iron ore producer Vale (15.5% of MSCI Brazil and 11.4% of the local index), rather than the Banks or Consumer plays.
The relative underperformance of Brazil versus EM (the local index is down 4% ytd compared to up 7% for MSCI EM) suggests an opportunity. But valuation is not that compelling: forward PB is 2.0x, a 20% premium to the 5-year median, for 16% ROE.
Across large EM we continue to prefer India, for its mix of post-Covid recovery and attractive relative valuation, as well as potential upside from rotation out of Tech, a legislative mandate for structural reform, and better US relations under Biden.
Related reading
Brazil deserves risk-on rally less than India, Russia or Turkey, November 2020
India: 7 charts to mark 72nd Republic Day, January 2021
Large EM equity strategy: India the best mix of growth-value, June 2020