After President Bolsonaro's disparaging of the judiciary and invoking a sense of all-or-nothing, during an Independence Day rally on 7 September, his hardcore supporters came uncomfortably close to emulating former US President Trump's hardcore base when it stormed the Capitol in Washington in January. The shadow of a divisive, disrupted, and disputed election in October 2022 lengthens.
Amid a raft of economic and political challenges, Bolsonaro has already lost support of the middle ground, which was a key component of his 2018 election win. His hardcore messaging risks alienating that base further. Meanwhile, there is every prospect of a rejuvenated, unified campaign from the political left, led by Lula.
Brazil equities already reflect a gloomy outlook but what about a coup?
Brazil equities have already substantially underperformed EM commodity exporter peers: down 1% ytd compared with South Africa (up 18%), Russia (up 30%) and Saudi Arabia (up 34%). Trailing price/book of 2.1x is a 10% premium to the 5-year median; closer to South Africa's 1% premium than Russia and Saudi Arabia's c40% premium.
Structural economic reform has already moved far off Bolsonaro's agenda (when was the last time anybody paid attention to finance minister and reformist champion Paulo Guedes?) and Brazil risks can be so comprehensively listed that they may already be reflected in valuation. Perhaps only a worst-case scenario of a termination of the electoral process altogether (ie a military coup) would truly jolt expectations lower.
This still looks a low probability but the retrenchment of Bolsonaro's rhetoric to the hardcore may indicate to any faction that supports him in the military that he needs their help. Whether they would derail Brazil's democracy in answering the call is a completely different matter.
Any commercial interests affiliated with any such faction would be hurt by a military coup, given the likelihood of capital flight, that US sanctions might ensue (it might be different if Lula was into Venezuela-style Chavismo, which he demonstrably is not) and that promotion would be throttled for those outside the faction (risking splits within the military).
Apart from recent performance and valuation, there are two potential fundamental silver linings for Brazil investors:
Brazil growth (and perhaps Bolsonaro's election prospects) may rebound faster than expected, precisely because Covid has been so mismanaged. The high prior infection rate (publicly disclosed registered cases equate to c10% of the population, which is very high by EM standards) may mean a high degree of immunity has been achieved (particularly, relative to others in EM, if the efficacy of vaccines wears off without additional boosters);
A Lula victory may not be all bad for markets: during Lula's tenure in 2003-10, the commodities super-cycle outweighed concerns over the socialist manifesto (if not all the policies and actions) of the Workers' Party and Brazil equities performed well.
Bolsonaro behind the election 8-ball
Bolsonaro faces a raft of challenges, heading into the October 2022 election:
Suspicion of corruption, either among his personal family (the "Rachadinha" case) or, perhaps more significantly, among some of the centrist politicians in his Centrao coalition (the "Covaxin scandal");
A resurrected popular political rival in Lula (who now enjoys a lead in August 2021 opinion polls of between 9% and 21%, depending on the source) and the middle-ground base of support that propelled Bolsonaro to victory in 2018 has clearly withered (eg his approval rating, as measured by Morning Consult, has plummeted from close to 60% in March 2020 to under 40% currently);
Economic growth is weak (under 2% real GDP growth in 2022, according to IMF forecasts) but high government debt (98% of GDP), high fiscal deficits (8% of GDP, according to IMF forecasts for 2021-22) and accelerating inflation (the consensus forecast has moved from 3.5% to 7.2%) shrink the space for policy stimulus. A significant increase in US yields might eliminate that space altogether (the current real interest rate is negative 4.7%).
Brazil: Lula's lead over Bolsonaro widens, June 2021
Bolsonaro unites Brazil opposition, May 2021
Democracy disappoints in LatAm, May 2021
The Brazilian blowout in equities in 10 charts, April 2021
Petrobras-induced sell-off makes Brazil valuations appealing, February 2021