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Our emerging markets (EM) equity team recently conducted a detailed country-specific review of Brazil that yielded some interesting and potentially actionable investment insights.
My bottom-line conclusion is a bullish one: I think Brazil’s market may offer an attractive path to potentially benefit from some of the country’s macroeconomic trends — particularly disinflation — in the period ahead. I believe now is an opportune time for EM equity investors to consider implementing or augmenting portfolio allocations to Brazilian equities.
Brazil weathered a strong and early inflationary cycle (relative to the rest of the world) that started in early 2020. The country has since experienced rapidly declining inflation, even as many other nations globally continue to grapple with reining in their persistently high rates of inflation (Figure 1). Falling inflation in Brazil may encourage downward pressure on interest rates, providing a catalyst for rising consumer spending and investment, all of which could be tailwinds for its equity market performance going forward.
On the interest-rate front, Figure 2 shows that Brazil’s real (inflation-adjusted) rate has room to come down, as it remains sharply elevated versus key EM and developed market counterparts. This stubbornly high real rate illustrates that Brazilian monetary policy has been meaningfully tighter than that of most other countries in recent years, the effects of which are now becoming apparent as inflation cools. Brazil has historically tended to run high positive real rates but typically closer to 4% (as compared to today’s 8%-plus level), so normalization of that number and continued disinflation should combine to bring interest rates down.
Looking ahead, I expect the Central Bank of Brazil to eventually undertake a concerted rate-cutting campaign that could provide a material boost to many Brazilian equities. This has often been the case in the past, although direct comparisons with previous cycles are difficult. Brazil’s high rates have precipitated a pronounced shift in investor inflows from equity to debt assets. As a result, Brazilian equities now appear quite cheap versus their own history and relative to the broader EM equity category (Figure 3). Once interest rates start dropping, investor capital may flow back into equities.
Along with the usual warnings and caveats that should accompany any call to invest in EM equities (greater market volatility, global currency issues, etc.), the main risk here is probably Brazil’s fraught, uncertain political landscape. Market sentiment and inflation expectations can turn quickly based on policy decisions, especially the Brazilian government’s ability to appropriately manage its finances. However, for discerning longer-term EM equity allocators, I believe Brazil offers a distinct investment opportunity at the present time.
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Equity Market Outlook
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Andrew Heiskell
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