Brazilian assets tumble after Lula's surprise win. Which equities could outperform?
Investors had spent recent weeks betting on a change in Brazil’s political leadership / Photo: kaliel creator / Shutterstock.com
Brazil’s currency, stocks, and bonds fell sharply after leftist incumbent President Luiz Inácio Lula da Silva defied market expectations and won the runoff presidential election to secure a fourth term in office.
Brazil’s benchmark Ibovespa stock index plunged 10% at Monday’s open, triggering an automatic trading halt. The iShares MSCI Brazil ETF, which tracks large- and mid-cap Brazilian stocks, fell more than 26% in premarket trading in New York. If those losses hold, Monday will mark the worst day for Brazilian stocks since at least 2000, the Wall Street Journal notes.
The Brazilian real weakened more than 8% against the dollar at the open.
Brazilian bonds sold off sharply. Some dollar-denominated issues were among the worst-performing emerging-market bonds in London trading, Bloomberg reports. The yield on bonds maturing in 2037, for example, jumped 19 basis points to 6.44%.
The selloff spread to European companies with operations in Brazil, particularly Spanish and Portuguese names. Santander, Spain’s largest bank, fell almost 4%. Brazil is its second-largest market. Spanish telecom group Telefónica, which owns Brazil’s largest mobile carrier, Vivo, dropped 7%. AB InBev, whose brands include South American favorites Skol and Brahma, fell more than 3.5%.
Which equities could outperform?
Amid the selloff, Citigroup analysts on Monday put together a list of “Lula picks,” stocks that could outperform the broader market following Lula’s victory, Bloomberg reports. The list includes homebuilder Cury Construtora e Incorporadora, aircraft maker Embraer, electrical equipment and automation giant WEG, and investment bank Banco BTG Pactual.
Bloomberg also highlights state-controlled oil and gas company Petrobras as a stock to watch. Following Lula’s reelection, the oil giant is expected to expand its reach and play a bigger role in the president’s industrial ambitions beyond oil production. The management is rebuilding the company’s presence in fertilizers, expanding refining, and even exploring opportunities in critical minerals. Petrobras also plans to step up exploration in the Equatorial Margin, a region with geological similarities to the oil-rich areas offshore Guyana and Suriname, where some of the world’s largest oil discoveries have been made in recent years.
Petrobras tops Seeking Alpha’s ranking of Brazilian stocks under its Quant Ratings system, with a “strong buy” rating. Brazilian stock exchange operator B3 and Banco Bradesco also carry bullish ratings under the quantitative system. Meanwhile, fintech Nu Holdings, miner Vale, bank Itaú Unibanco, and industrial equipment maker WEG S.A. have “hold” ratings.
What analysts are saying
Brazil’s election result caught markets off guard, with investors betting on a victory for right-wing candidate Flávio Bolsonaro, who had led after the first round, Bloomberg reports. Brazilian assets had been rallying since August as investors anticipated that a change in political leadership could bring tighter fiscal policy, corporate tax reform, and potential privatizations. Those measures could help contain government debt growth and eventually lower borrowing costs.
Lula’s team has pledged to achieve a budget surplus of around 1.3% of GDP by 2030. That would free up funds to cover part of the interest bill on government debt and reduce the need for new borrowing. However, Brazil’s public debt already exceeds 82% of GDP, while pensions and other legally mandated spending limit the scope for cuts.
The “Lula administration will have no choice but to do some fiscal consolidation too,” Thierry Larose, a portfolio manager at Vontobel Asset Management, told Reuters. However, most investors doubt that the measures will be sufficient to put government debt back on a sustainable path.
Unless investors are confident that Lula can meet his targets, lenders could demand higher interest rates. That would add to Brazil’s debt burden and make credit more expensive for businesses and households. Alejo Czerwonko, chief investment officer for emerging markets at UBS Global Wealth Management, expects investor sentiment to remain weak until the administration presents a clear fiscal plan.
Bolsonaro’s refusal to concede and his pledge to seek an annulment of the election result have added to investor uncertainty. “Important for local financial markets will be how quickly Bolsonaro accepts the result – or at least allows the constitution to run its course,” Chris Turner, an ING strategist in London, told Reuters.
