Brazil in investment sweet spot amid countdown to election
The Brazilian markets' remarkably calm behaviour leading up to the October Presidential election demonstrates the success of the political and economic improvements over the past decade and strengthens the investment case for this country, according to HSBC Global Asset Management.
Perceived political risk in the run-up to Brazilian presidential elections has historically destabilised Brazilian assets and the currency. For example, in 2002 the Bovespa equity index and the local currency both plunged by more than 40% as investors panicked about the possible outcome. This time around, with the election approaching, there is no such sign of concern, let alone panic, according to Philip Poole, Global Head of Macro and Investment Strategy at HSBC Global Asset Management.
He said political and economic improvements over the past decade, together with de facto central bank independence, have fundamentally changed the investment landscape in Brazil. This should give investors further confidence that although Brazil represents a strong investment opportunity, the level of associated risk has been substantially reduced.
A further example is Brazil's relatively ‘comfortable' crisis, reflecting a sound economic management and a banking system that had already been purged of excess leverage, Poole adds.
Jose Cuervo, co-manager* of the USD2bn HSBC GIF Brazil Equity fund, said the investment case looks sound. Brazil is experiencing strong economic growth this year which should top 7%, then moderating to 4.5 to 5.0% over the next few years. Concerns over inflation have been easing recently as the year-on-year comparisons begin to ease. Although the tightening on this monetary cycle is not over, we do not expect interest rates to be hiked materially over the coming months as inflation is not rising out of control.
"Brazil is therefore in an economic and investment "sweet spot", where the domestic economy is growing fast, but not so fast that inflation is getting out of control. The global environment is weak, but not so weak that it is affecting Brazil, yet it is keeping interest rates in Brazil low. This is a potentially ideal economic and investment environment," he said.
Cuervo said in addition to strong GDP growth, Brazilian equities should continue to benefit from earnings upgrades. Earnings per share (EPS) growth for the MSCI Brazil index stands at 28.6% for 2010 and 25.6% for 2011.
Meanwhile, the market appears relatively cheap compared to BRIC peers, trading on a 2010 forward multiple of 11.6x compared to 13.8x for China and 18.7x for India.
Within the equity markets, Cuervo said domestic stocks are particularly appealing with support from robust consumption, favourable demographics, a buoyant labour market and rising real wages. Commodity stocks should also eventually benefit when it becomes clear that hard landing concerns over China are overdone.
Poole said there also remains value in Brazilian fixed income, as part of a broader positive trend in emerging debt. Yields are likely to stay very low across external and local debt markets with a general compression of spreads in line with the rest of the asset class. Carry currencies, including the Brazilian real, are also providing a compelling story given the dearth of yield on offer in the developed world and the G3 commitment to loose monetary conditions
Poole added that there are still risks with Brazil, but these are mostly external. For example, Brazil would not be immune to a global ‘double dip' recession, though this is not HSBC's expected outcome. Another concern is that like many other commodity exporters Brazil is exposed to China.
"The slowdown in China is part of the reason for recent global jitters but HSBC's view is that China is slowing not melting down and the recent data is supporting this," he said.
HSBC Global Asset Management is one of the world's largest investors in emerging markets with approximately USD93bn in emerging markets assets, including approximately USD28bn in BRIC assets. Brazil is an important market. HSBC Global Asset Management manages USD42.3bn in Brazilian assets, including USD25.4bn in Brazilian fixed income (as at end August).