-
The Central Bank of Brazil first cut its benchmark interest rate by half a percentage point on 2 August 2023 after carrying out one of the most aggressive tightening. It had cut interest rate for a third time on 1 November 2023, bringing its benchmark Selic rate to 12.25%.
Embarking on monetary easing would create a supportive backdrop for Brazilian equities, especially when many global central banks are still rather hawkish. Not to mention, Brazil’s economy also grew more strongly than anticipated, with upwards revisions to its GDP.
Policy concerns in Brazil have moderated, with Brazil's lower house having approved a new fiscal framework proposed by President Luiz Inacio Lula da Silva, which is moving towards improving fiscal balances.
Despite some setbacks, we continue to maintain a positive outlook for commodities which will benefit Brazilian economic growth and corporate earnings.
Valuations for Brazilian equities remain attractive, and we see an upside potential of 37% by 2025 and retain our Star Rating for Brazil at 3.5 Stars “Attractive”.
Brazil has been a strong performer year-to-date (YTD), delivering returns of around 10%, outperforming many other markets (Figure 1). Previously, we have articulated our positive view on Brazilian equities, and continue to reiterate this.
Related article — Brazil: Look to this 2022 top performer to repeat its stellar performance
Figure 1: Brazil delivered strong returns year-to-date
Brazil has started cutting interest rates
Figure 2: Brazil’s inflation figures 
The International Monetary Fund (IMF) has also identified Brazil as one of the countries with a higher-than-anticipated GDP expansion in 2023. Reasons behind Brazil’s stronger expected economic growth include the expansion of agriculture, the resilience of the service sector, and increased consumption. The Brazilian economy is projected to grow by 3.1% this year, and this figure is one percentage point higher than the previous estimate in July by the institution. For 2024, the growth estimate for Brazil’s GDP is 1.5%.
Besides the IMF, Brazil’s central bank also raised its 2023 economic growth forecast to 2.9% this year, which is more than the 2% growth estimate from June and estimates a GDP growth of 1.8% for 2024 (Figure 3).
Figure 3: Brazil’s Central Bank GDP growth estimates
Policy concerns have moderated
The election of leftist Luiz Inacio Lula da Silva as Brazil’s president by the narrowest of margins in late October of last year was expected to herald a very different policy approach to former far-right President Jair Bolsonaro.
Despite this, policy concerns in Brazil have since moderated. Brazil's lower house approved a new fiscal framework proposed by President Luiz Inacio Lula da Silva on 22 August 2023. The proposed fiscal rule is arguable the most consequential economic achievement of the president so far. Markets appear pleased with the new fiscal framework which helped to quelled concerns that his ambitious social spending goals would balloon the deficit, boosting appeal to investors.
Under the new fiscal rules, government expenditures will not be allowed to rise by more than 70% of any increase in revenue, with spending growth also limited to between 0.6% and 2.5% per year above inflation. If the goals are not met, expenditure growth will be restricted to 50% of revenue increases as a penalty. A better fiscal outlook could help reduce inflation risks, and more importantly, the approval of this new policy signals that the administration is shifting its stance on improving fiscal balances. This is crucial as Brazil’s government debt has increased in recent years (Figure 4).
Figure 4: Brazil’s net debt to GDP has increased 
Supportive commodities outlook remains despite some setbacks
Figure 5: Stronger commodity prices often drive Brazil’s export value
Second, due to the outsized allocations of the Materials (21%) and Energy (18%) sectors in the Bovespa Index (Figure 6), higher commodity prices also help to uplift revenue for these two heavyweights, thereby enhancing aggregate earnings for the index.
Figure 6: Materials and Energy are two of the three largest sectors in
the Bovespa Index
We remain optimistic on commodities prices moving ahead, despite currently seeing yoy decreases due to high base effects from 2022, where the Russia-Ukraine war first broke out. A major factor underpinning the commodity market’s strength in recent years is the significantly tight supply.
For instance, oil prices have rallied since mid-June due to tighter supply outlook, resulting from production cuts from Russia and Saudi Arabia, alongside optimism from OPEC regarding global oil demand as major economies are stronger than expected. The recent Israel-Hamas war has also led to higher oil prices due to fears that further escalation would disrupt supplies. Moreover, structurally, the oil and gas sector is defined by underinvestment as producers maintain capital discipline. This is a persistent problem that is difficult to change, with investment being on a downward trend since peaking in 2014.
Meanwhile, the medium to long-term outlook for metals looks attractive, as the energy transition becomes a priority and represents a significant driver of incremental demand for copper, nickel, lithium, and other metals which are essential in renewable technologies.
Related articles:
Oil prices nearly hit USD 100. Here’s why we are paying close attention
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Commodities are down but not out. Here’s why the bull market is far from over.
Key investment risks
Political risks: Politically-motivated protests and riots are not entirely uncommon in Brazil - what is worth watching in our view is the potential for economic spillovers from such protests. One instance was the 2018 trucker riot which saw truck drivers blocking traffic across Brazil, crippling the nation’s agricultural sector and driving food prices higher. The riot was estimated by USDA to have caused USD 1.75 billion in losses for the agricultural sector.
Moreover, given that Luiz Inácio Lula da Silva defeated the far-right incumbent Jair Bolsonaro by a very small margin in October 2022, Brazil remains politically divided. While political risks may have since abated, future elections can serve as a source of volatility.
Inflation risks: Despite having already embarked on monetary easing, the BCB needs to proceed with caution as the recent Israel-Hamas war could increase the risks of higher oil prices and volatility that could stoke inflation. Investors may witness inflation spiking upwards, and a higher than expected inflation may put a pause the monetary easing cycle.
Slowing demand from China: The slowdown of the Chinese economy is another risk to take note off. The world’s second-largest economy has become mired in a spiraling real estate crisis that has been reverberating across markets and causing worry to major trade partners. China is Brazil’s largest trading partner (Figure 7), accounting for nearly a third of all Brazilian exports. A deceleration in China could dampen demand for Brazilian products.
Figure 7: China is Brazil’s dominant
trade partner 
Valuations for Brazil remain very attractive
We believe Brazilian equities would continue to be buttressed by a supportive commodity outlook over the long-term, alongside an additional tailwind of looser monetary policy going forward. Policy concerns have also since moderated with the passing of a new fiscal framework which signals that the administration is shifting its stance on improving fiscal balances. Currently, Brazilian equities continue to look attractively valued relative to its historical basis, trading at a forward P/E ratio of about 8.8X (Figure 8).
Figure 8: Brazilian equities are cheaply valued 
While our outlook for Brazil over the longer-term remains optimistic, we nevertheless expect earnings to decline for Brazilian equities in 2023 seeing the decrease in commodity prices relative to the high base effects from 2022. Moreover, the global economy continues to be faced with headwinds coming from high inflation and interest rates. Lastly, China who is Brazil’s largest trading partner is experiencing slowing growth, which could dampen the demand for Brazilian’s exports impacting its earnings. However, following which, we expect earnings to rebound by +10% YoY in FY24.
Using our fair P/E ratio of 11.5X, we project a target price of around BRL 155,420 for the Bovespa Index by FY25, giving a potential upside of 37%. We maintain our Star Rating of 3.5 Stars “Attractive” for Brazilian equities.
Investors seeking exposure to Brazil via a passive approach should consider the iShares MSCI Brazil ETF (NYSE:EWZ), which is one of the largest and most liquid Brazilian equity ETF. For an active approach, investors can consider our recommended fund for Brazil - JPM Brazil Equity A (acc) SGD Fund.
Table 1: Earnings estimates for Brazilian equities
|
Brazil (Bovespa Index) |
FY22A |
FY23E |
FY24E |
FY25E |
|
PE Ratio (X) |
5.81 |
9.67 |
8.79 |
8.37 |
|
Expected Earnings Growth YoY |
17.0% |
-38.0% |
10.0% |
5.0% |
|
Earnings Per Share |
18,873 |
11,701 |
12,871 |
13,515 |
|
Projected
Fair Price |
- |
- |
- |
155,417 |
|
Potential Upside from Today (%) |
- |
18.9% |
30.8% |
37.4% |
|
Source: Bloomberg Finance L.P., iFAST compilations, iFAST estimates. Data as of 1 Nov 2023 |
||||
Table 2: Recommended products
|
|
ETF |
Unit Trusts |
|
Brazil |
iShares MSCI Brazil ETF (NYSE:EWZ) |
Figure 9: Earnings forecast and price performance
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