Strategy Note /

Brazil: Lula beats Bolsonaro – winning was hard, governing will be harder

  • Leftist challenger Lula beat rightist incumbent Bolsanoro by 1.8 points in the 2nd-round presidential election

  • Lula now has to manage congress, over which he exerts very little control, to cut fiscal deficit (7.5% of GDP in 2023)

  • Brazil equities and currency are cheap vs. the historical average and by more so than most large emerging market peers

Brazil: Lula beats Bolsonaro – winning was hard, governing will be harder
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
31 October 2022
Published byTellimer Research

Leftist challenger Lula defeated rightist incumbent Bolsanaro in the second-round presidential election on 31 October.

After 99.5% of votes were counted, his margin of victory in the run-off was 1.8 percentage points. While the margin of victory is tighter than that implied by pre-election opinion polls, a Lula victory was expected.

Winning the election was hard. Governing via a highly fragmented congress will be harder. And that makes it unlikely that Brazil will tackle its high fiscal deficits and government debt any time soon.

However, as long as commodity prices provide a tailwind, Brazil equities should continue to perform well – up 14% year to date, far outstripping large emerging market peers.

Brazil's equities and currency are also cheaper versus historical averages than most large EM peers and its real interest rate is the highest in EM.

Lula wins, waiting for Bolsanaro to concede

Bolsanaro performed better than expected by winning most of the share of votes captured by centrist candidates in the first round.

Brazil: Lula wins despite Bolsonaro outperforming pre-election opinion polls by capturing centrist candidate votes

While the margin of defeat, merely 1.8 percentage points, may embolden him to dispute the results, prolong the transition or disrupt the electoral process altogether, we regard extra-constitutional actions as unlikely.

Nevertheless, his reaction to defeat has been a commonly held concern prior to the election and, at the time of writing, this remains unresolved.

Fiscal challenge ahead

The caricatures painted by their political opponents are of Lula the market-unfriendly, sell-out socialist, kleptocrat and Bolsonaro the crass, corrupt, environmentally destructive, borderline fascist. They were certainly two very different contestants in this second round, appealing to polarised camps among the electorate.

From an investor's perspective, neither is Lula so market-unfriendly as to derail the fundamental drivers, should they remain positive (eg commodity prices), nor is Bolsanaro so market-friendly (and immune from the populist fiscal impulse) that Brazil's equities cannot perform without him.

There is a lot of focus on Lula's choice of finance minister but that ignores the difficulties faced by a technocratic champion of fiscal orthodoxy, Paulo Guedes, to push fiscal reform through the president that appointed him at the start of 2019 and the congress that passes law.

The IMF forecasts a fiscal deficit of 7.5% of GDP and gross government debt of 88%. To push through the difficult structural reforms that are needed to improve these metrics requires a collaborative relationship between the president and congress. But the prospects of that are not good.

Brazil structural challenges unlikely to be met any time soon

Congressional obstructionism ahead

The key change after this election is not the personality of the president but the dimmer prospect of cooperation between the president and congress.

After the early October legislative election, neither Lula nor Bolsanaro could lay claim to a coherent, stable ruling coalition.

  • Lula's closest bloc (Brazil of Hope – made up of the Workers', Communist and Green parties) in the lower house has 16% of seats.

  • Bolsanaro's closest bloc (the Liberal Party — made up of Bolsanaro loyalists who recently joined and traditional 'Centrao' politicians) has 19%.

But, in a highly fragmented congress, arguably the blocs more likely to cooperate with Lula are smaller than those who will likely strive to protect the rightist political agenda until the next election in 2026.

Brazil's highly fragmented Congress

Cheap equities and currency

Brazil equities (Ibov Index) are up 14% ytd in total US$ return terms, far outperforming MSCI EM (down 29%). Brazil's currency is up 5% ytd.

Brazil's equities and currency are also cheaper versus historical averages than most large EM peers.

  • Trailing Price/Book is 1.6x (for 25% trailing ROE), a 15% discount to the five-year median.

  • Forward Price/Earnings is 6.6x (alongside consensus 2023 earnings decline of 7% and a dividend yield of 7.7%),

  • Should the real effective exchange rate revert to the 10-year median then this implies c20% upside to the spot FX rate.

  • The real interest rate (policy rate minus last reported inflation) is positive 6.6%, far in excess of the rest of EM.

Brazil equities cheaper vs history than much of large EM

Brazil has the cheapest currency in large EM equity markets

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