If Brazil’s economy is still crawling, why are stocks soaring?

. Mar 20, 2019
brazil economy stock market

This week, the São Paulo stock market index reached its all-time nominal high, breaking the 100,000-point barrier and bringing some symbolic joy to Brazilian investors. On the same day, the Central Bank’s weekly survey of financial institutions showed that investors have lowered their expectations for the GDP growth of the country, from 2.28 to 2.01 percent.

How can Brazil be in a bull market, while the real economy remains sluggish? And how long will the stock market frenzy last?

The very nature of how markets—and business cycles—work can bring a possible explanation for what we are seeing. The market tends to anticipate economic movements, therefore growth and recession periods are normally felt in advance.

As noted by Raphael Figueiredo, a strategist at Eleven Financial Research, “the stock exchange is the representation of future profit expectations in present values. If more profits are expected, we will have more business activity. Therefore, the bigger the activity, the better the perception about the economic recovery,” he said in a report to clients.</span></p> <hr> <p><img loading="lazy" class="alignnone size-large wp-image-14940" src="" alt="brazil economy stock market" width="1024" height="683" srcset=" 1024w, 300w, 768w, 610w, 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr> <p><span style="font-weight: 400;">“For me, it is clear that the market anticipated itself and we can expect a cyclical recovery of our economy soon after,” Mr. Figueiredo wrote.</span></p> <p><span style="font-weight: 400;">Comparing Ibovespa’s historical performance and </span><a href=""><span style="font-weight: 400;">Brazil&#8217;s GDP</span></a><span style="font-weight: 400;">, the correlation does make sense. In 2013, two years before the worst recession in Brazil’s history, GDP grew 3 percent, while Ibovespa dropped 15.5 percent. On the other hand, in 2016, in the middle of the crisis, GDP slumped 3.3 percent, but Ibovespa rose an impressive 38.9 percent, among expectations of pro-market measures and a fiscally responsible government after the impeachment of President Dilma Rousseff.</span></p> <p><span style="font-weight: 400;">Back in 2019, Ibovespa is gaining around 12 percent this year. But with market forecasts continuously being made less and less optimistic, people are starting to wonder if this streak is sustainable.</span></p> <hr> <p><img loading="lazy" class="alignnone size-large wp-image-14941" src="" alt="brazil economy stock market" width="1024" height="567" srcset=" 1024w, 300w, 768w, 610w, 1200w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr> <p><span style="font-weight: 400;">There are some factors that support the upside. Although it is true that the 100,000-point threshold is significant, the index is still way below its historical peak in USD, as we mentioned this week in our </span><a href=""><span style="font-weight: 400;">Daily Briefing newsletter</span></a><span style="font-weight: 400;">. Looking at the Ibovespa index in USD instead of focusing on the nominal number, we showed that Brazilian stocks are actually “cheap” on a broader perspective. </span></p> <p><span style="font-weight: 400;">Besides, Brazil’s benchmark interest rate (Selic) is at its lowest level ever: 6.5 percent. As economic activity remains sluggish, it is likely that Brazil’s Central bank will </span><a href=""><span style="font-weight: 400;">keep the rate at current levels</span></a><span style="font-weight: 400;">, making investments with a bigger return—such as stocks—more attractive, increasing the demand for assets.</span></p> <hr> <p><img loading="lazy" class="alignnone size-large wp-image-14942" src="" alt="stock market usd" width="1024" height="483" srcset=" 1024w, 300w, 768w, 610w, 1962w" sizes="(max-width: 1024px) 100vw, 1024px" /></p> <hr> <h2>Make or break year for Brazil</h2> <p><span style="font-weight: 400;">However, once again, market cycles are boosted by expectations. Even though there are plenty of technical elements that make Ibovespa a logical choice for investors, politics—and its implications on the economy—are set to be the “</span><a href=""><span style="font-weight: 400;">make or break</span></a><span style="font-weight: 400;">” factor for the Brazilian market in 2019.</span></p> <p><span style="font-weight: 400;">Although the speeds are different, economists see the progress of both the Brazilian stock market and the real economy deeply connected to the approval of the pension reform project. Slashing the government&#8217;s expenditure on social security gives more room for investments in </span><a href=""><span style="font-weight: 400;">healthcare</span></a><span style="font-weight: 400;"> or education. Besides, balancing the public accounts sends a positive message to investors that the government will be able to honor its financial commitments, helping to bring foreign capital to the country. </span></p> <p><span style="font-weight: 400;">Currently, salaries and pensions account for the biggest chunk of the federal budget in Brazil. Failing to tackle the issue is considered the worst case scenario for investors and the government—and that explains why expectations surrounding it are driving stock market profits. </span></p> <p><span style="font-weight: 400;">For the past few weeks, Ibovespa has been closely following the news about the bill’s progress through Congress—and it will likely remain this way until the proposal is approved, according to Pablo Spyer, director at brokerage Mirae Asset.</span></p> <p><span style="font-weight: 400;">“I see this as a binary scenario, but with upside. There is a risk of Congress not approving the bill. But if markets believed that, the [stock market] wouldn&#8217;t be rising. I think there is a consensus that it will be approved. It is true that the market has already anticipated some of the profits, but if a ‘super revamp’ happened, Ibovespa could go even higher,” he told </span><b>The Brazilian Report. </b></p> <p><span style="font-weight: 400;">Despite the market&#8217;s euphoria, negotiations in Brasília around the pension system promise to be tough—and many of the bill&#8217;s supporters have complained of President Jair Bolsonaro&#8217;s seemingly non-committal behavior towards the reform. However, providing the government is able to pass a bill before the end of the year, which results in at least BRL 600 billion of savings for the public treasury over the next 10 years, the good faith of the market should persist.

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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