The starter pistols have been packed away and the swampy swimming pools have been drained, but what’s next for Brazil after the Olympics? For decades, Latin America’s largest economy was a vibrant and attractive proposition for Canadian advisors looking to add some emerging markets exposure to their portfolios. But things have changed in recent years. The combination of political struggles, caused by the 2014 elections, and the slump in oil prices had a hugely negative impact on Brazil’s economy.
“It was the perfect storm of negative events,” says Christine Tan, Chief Investment Officer, Excel Investment Counsel Inc. “In 2015, the Brazilian economy had its worst year since the great depression: the economy contracted 3.8% and inflation went into the double digits. The strong U.S. dollar and weak commodities also had a major impact.”
But things are finally looking up for Brazil, the world's ninth largest economy. The IMF is forecasting that the country will emerge from recession next year, which is in line with the market’s call for earnings to follow the expected GDP growth. “Sometimes it takes the economy getting so bad for a change to occur,” Tan says. “The recovery started when, at the beginning of this year, there was an acceleration of dissatisfaction with the incumbent, which finally led to the impeachment of Dilma Rousseff due to her handling of the fiscal budget.”
Rousseff was suspended for several months and her Vice President Michel Temer, a lawyer by trade, stepped into the role. Viewed as a business-friendly technocrat, Temer replaced certain senate members with pro-business politicians, which was widely viewed as a positive move. “All of this meant that the political risk premium in Brazil was lifted; as a result, the Brazilian real rallied and inflation is now under 10%,” Tan says. “This reversal happened very quickly.”
Since taking the helm, Temer has attempted to enact several reforms and policies, one of which will limit the increase in fiscal spending to prior year inflation. “This will mean the fiscal deficit as a percentage of GDP will decline, and that’s also highly positive,” Tan says. “Obviously, the recovery of oil prices has helped Brazil, too. A lot of the negative events of 2014 have been reversed.”
But what does Brazil’s improved performance mean for Canadian advisors? “Because the rally in Brazilian equities has been short, I think we’re going to go through a period of consolidation and potentially higher volatility,” Tan says. “Assuming that earnings continue to recover, I still see Brazil as one of the more inexpensive markets. If earnings stay at low levels, the market looks expensive but I think there is more room for improvement, especially if you consider that interest rates are still at 14.25%.”
Any advisor considering adding Brazilian exposure to their portfolios in the midst of the rally must be comfortable, and prepared for, some potential pullback. Gaining exposure through a broader Latin American portfolio is one strategy that Tan suggests. “We have a fund that is 55% Brazil, 25% Mexico with the rest made up of Peru, Chile and Colombia,” Tan says. “That’s what I would do as an advisor. Advisors who want Brazil exposure but with even less concentration could consider participating through a broader emerging markets fund.”