The opinion poll lead of former leftist President Lula over incumbent rightist Bolsonaro is back to 20 percentage points in second-round voting scenarios for this October's election. This lead had narrowed to 15pp after Bolsonaro announced a new welfare plan in October 2021.
This week, Lula suggested his running mate could be centrist Geraldo Alckmin, a former Sao Paolo governor (elected three times) and presidential candidate (losing in the second round to Lula in 2006), who is associated with privatisation and fiscally prudent policies.
This public statement follows Lula's meeting with centrist former President Cardoso in May 2021. Lula's public courting of the political centre should allay the fears of some of a radical, market-unfriendly shift leftwards in Brazil's government after the election.
The likelihood of political transition should not scare off investors in Brazil, as we have argued before: neither has Bolsonaro demonstrated commitment to structural reform, particularly fiscal control, when under pressure from Covid and declining approval ratings, nor did Lula's 'socialism' stand in the way of a commodities-driven rally in Brazil equities during his 2003-10 stint as president.
The risk of Bolsonaro rejecting the outcome should he lose the election is more concerning than that of a Lula victory. Mitigating this risk is that the bulk of the military is unlikely to support any subversion.
Persistent high fiscal deficits and the risks from slowing China demand growth, particularly for iron ore, are the key risks in the top-down Brazil investment case, but the following factors make the case in its favour:
Commodity price tailwind for its main exports – agriculture products are over 30% of total exports, iron ore and related products are 15%, and crude oil is 10%;
Covid-related disruption and lockdowns should soon fade – the full vaccination rate is now 76% and 11% of the population have already been infected;
Cheap valuation of equities (Ibovespa index) relative to history – trailing PB of 1.8x (for 26% ROE) is at a 10% discount to the 5-year median, forward PE of 8x (for consensus earnings decline of c10% in 2022 but dividend yield of 7%); and
Cheap valuation of the FX rate relative to history – a return to the 10-year median real effective exchange rate implies 35% upside to FX rate, FX reserves import cover is 18 months, the current account deficit is below 2% in 2022 (according to IMF forecasts), short-term external debt to GDP is merely 5%, and after 575bps of policy rate increases since the start of 2021, the real interest rate is now negative 2.3%.
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