Domestic Bonds

The Brazilian market attracts value-oriented investors. Don’t expect a carnival.

Brazilian markets are booming while other global markets are lagging behind.

Quinn Rooney/Getty Images

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Here’s something you probably didn’t see coming: Brazilian markets are booming, while the rest of the world is crashing.

the


iShares MSCI Brazil

The exchange-traded fund (ticker: EWZ) has jumped 17% since the start of the year. Global emerging markets are up 2%, the


S&P500

is down 4%. The real appreciated by 7% against the dollar.

With two-thirds of its market capitalization in materials or financial stocks, and a 32% drop in 2021, Brazil was something of a paradise for value-spinning investors.

It’s always like that. “Brazil is trading at a 30% discount to historical averages, while the rest of the world is at a 5% premium,” says Daniel Gewehr, portfolio manager at São Paulo-based WHG Asset. “There should be positive stock returns over a 12-24 month period.”

Don’t expect a smooth escalator, though. Brazil’s central bank hiked interest rates from 2% to 10.75% in one year, chasing runaway inflation, and it’s probably not done yet. This will reduce growth to zero at best for 2022. Corporate earnings per share could fall 12%, Gewehr predicts. Local investors are fleeing equities to savings as yields there soar.

Then there’s the small matter of a presidential election in October with the likely and nasty pick of erratic incumbent Jair Bolsonaro over his leftist predecessor Luiz Inácio Lula da Silva. The news flow should ensure more thrills and spills in the market. “Tactically, you’re going to see a pretty wild ride,” predicts Alejo Czerwonko, investment director for emerging markets in the Americas at UBS Global Wealth Management.

The cheapness argument reigns supreme for Allison Fisch, emerging markets portfolio manager at Value


Pzena Investment Management
.

“We bought some very good companies in Brazil that would have been too expensive before,” she says. For example,


Itau Unibanco Holding

(ITUB), which jumped a quarter this year, is still at a third of its pre-pandemic price. She also likes the beer maker


Ambev

(ABEV), which has yet to run in 2022, and “bond proxies” like a power producer


Company Energy of Minas Gerais

(CIGARETTE). Its dividend yield is close to 5%.

Investors overreacted to last year’s bad news on inflation and the pandemic, and missed good news like the fiscal squeeze that generated a primary budget surplus, adds Pablo Riveroll, head of Latin equities. Americans at


Schröders
.

Debt, which was supposed to break 100% of gross domestic product, rose to 86% instead.

Banks have maintained strong loan portfolios and are poised to swing as rates and inflation approach their peak. “We continue to think Brazil offers pretty good value both in currency and in equities,” he says. “Banks will have pricing power once you have rate stability.”

Jeff Grills, head of emerging market debt at Aegon Asset Management, will believe this stability when he sees it. The central bank “will have to stay higher longer to convince people that it is serious,” he says. This means no growth and little investment to support the real as inflation continues to eat away at it. Throw the election and “the currency should trend lower,” undermining both bonds and equities.

One category no one seems keen on buying is fallen Brazilian tech angels like


Digital PagSeguro

(PAGS) and


StoneCo

(STNE), both at a fraction of the highs reached a year ago. “Stone failed miserably to move from payments to loans and PagSeguro didn’t try,” says Riveroll. “It’s the revenge of the old economy.

Investors inclined to bet on this rematch globally will want to watch Brazilian names with caution.