What to expect from Brazilian markets after the pension reform?

. Jul 11, 2019
pension reform advances markets reactions São Paulo stock market B3

Since reaching its lowest point for 2019 in May (dropping to 89,000 base points), breaking new record-highs has become the norm for Ibovespa, Brazil’s benchmark stock index. Over the past two months, the index has risen 16 percent, fueled by investors’ optimism regarding the pension reform’s progress in Congress. But politics and financial markets work at a different pace. And that’s why, after months of euphoria, investors are already beginning to worry about the future—before the reform has even left the House

The progress Brazilian markets have made so far is, ironically, one of the reasons for investors getting cold feet.

</span></p> <p><span style="font-weight: 400;">In 2017, the country seemed poised to overhaul its pension system—until the so-called &#8220;Joesley Day.&#8221; Audio recordings showed then-President Michel Temer apparently asking businessman Joesley Batista to pay hush money to a jailed former House speaker. Mr. Temer managed to cling on to his office—but lost all his political capital, which he needed to broker a reform.</span></p> <p><span style="font-weight: 400;">Since that day, Ibovespa levels have risen 66 percent. 2019 could be the fourth consecutive year with double-digit gains for the stocks index.</span></p> <p><span style="font-weight: 400;">Market operators also have their eyes on the international stage. The </span><a href=""><span style="font-weight: 400;">U.S.-China trade war</span></a><span style="font-weight: 400;"> may reduce the Asian giant&#8217;s </span><a href=""><span style="font-weight: 400;">appetite for commodities</span></a><span style="font-weight: 400;">, and the global economy as a whole seems to be losing steam. The Organization for Economic Co-operation and Development (OECD), for example, has already cut global growth projections for the year, from 3.5 to 3.2 percent. </span></p> <p><span style="font-weight: 400;">But even if outside factors require investors&#8217; close attention, as any steep deterioration in the global scenario will certainly reflect on Brazil, the country is emerging as an attractive investment option, according to Pablo Spyer, director at the Mirae Asset brokerage firm.</span></p> <p><span style="font-weight: 400;">“The pension reform is the anchor for the country’s fiscal credibility, which is crucial to provide growth with low interest rates and small inflation. The market is already betting on a 0.5-percent cut in the benchmark interest rate. An environment with lower interest rates is very positive for stocks,” he told </span><b>The Brazilian Report</b><span style="font-weight: 400;">.</span></p> <p><span style="font-weight: 400;">Even though Brazil has yet to recover its investment grade, Mr. Spyer points out that current conditions are appealing to foreign investors, who may bring money not only to the stock markets, but also to </span><a href=""><span style="font-weight: 400;">Brazil’s infrastructure</span></a><span style="font-weight: 400;">—a much-needed boost for an ailing economy.</span></p> <p><span style="font-weight: 400;">“I believe foreign investors want the approval to be confirmed. After that, we expect trillions of dollars in </span><a href=""><span style="font-weight: 400;">foreign direct investments</span></a><span style="font-weight: 400;">, in ports, airports, roads,” he adds.</span></p> <p><span style="font-weight: 400;">That may take a while. The House has just approved the reform in one of two rounds of votes—and the Senate has yet to weigh on it, too. If Senators change anything, then the whole bill is sent back to the House.</span></p> <h2>Is the sky the limit?</h2> <p><span style="font-weight: 400;">On the afternoon of July 10, Ibovespa hit its all-time intraday high of 106,000 points. But this record is measured in BRL—a much more volatile currency and subject to fluctuations and losses. Measuring Ibovespa in U.S. Dollars, and we see it is actually ranging around 28,000 points, way below the 44,000 high of 2008, per TradingView data.</span></p> <p><span style="font-weight: 400;">Analysts are optimistic on both terms. </span><a href=""><span style="font-weight: 400;">XP Research expects</span></a><span style="font-weight: 400;"> Ibovespa may reach 125,000 points (in BRL) in the next 12 months and 140,000 by the end of 2020.</span></p> <p><span style="font-weight: 400;">In their recommended portfolio for July, BTG Pactual bank analysts see that “once the reform passes, Ibovespa could quickly trade one standard deviation above average. Using our 12-month forward earnings, this puts the index around 119,000 points, offering an upside of 17 percent.”</span></p> <div class="flourish-embed" data-src="visualisation/489642"></div> <p><script src=""></script></p> <h2>Beyond the charts</h2> <p><span style="font-weight: 400;">Stock fundamentals are often moved by the projection of future gains—namely, corporate profits, propelled by better economic conditions. At this point, Brazil is expected to </span><a href=""><span style="font-weight: 400;">grow a mere 0.82 percent</span></a><span style="font-weight: 400;">, according to economists heard by Brazil’s Central Bank for its weekly Focus Report. If confirmed, that would be even lower than the 1 percent registered in 2017 and 2018.</span></p> <p><span style="font-weight: 400;">Per BTG Pactual analysts, this can </span><a href=""><span style="font-weight: 400;">indeed lower profit expectations</span></a><span style="font-weight: 400;"> for the next 12 months. But, as investments are expected to pour in, creating jobs and rekindling confidence and consumption levels, analysts expect companies will thrive and their stocks will reflect this bonanza.</span></p> <p><span style="font-weight: 400;">&#8220;Higher profits for listed companies are not priced in yet. Some sectors will report a much bigger growth than Brazil&#8217;s average GDP and even the market&#8221;, wrote Eduardo Guimarães, a stock analyst at Levante Investimentos, in a recent column. “My favorite sectors in stock markets are financial (banks), construction, retail, car rental, transport, and infrastructure.&#8221;</span></p> <p><span style="font-weight: 400;">He also highlights the </span><a href=""><span style="font-weight: 400;">record of 1.1 million investors coming to B3</span></a><span style="font-weight: 400;">, São Paulo stock exchange, increasing the money influx to the local market, which may be even bigger with a lower Selic rate.</span></p> <h2>Full-house renovation</h2> <p><span style="font-weight: 400;">Even cabinet members and lawmakers realize that the pension reform creates positive growth conditions, but won’t solve all of Brazil&#8217;s problems on its own. That’s why investors are also keen on </span><a href=""><span style="font-weight: 400;">other market-friendly measures being carried forward</span></a><span style="font-weight: 400;">.</span></p> <p><span style="font-weight: 400;">As BTG Pactual highlights, the government’s privatization project gained a boost after the Supreme Court decided that state-owned subsidiaries may be sold without legislative approval. This would be a relief for</span><a href=""><span style="font-weight: 400;"> companies such as Petrobras</span></a><span style="font-weight: 400;"> and Eletrobras, who are working to reduce their high debt levels. </span></p> <p><span style="font-weight: 400;">Also, a tax reform is also on the go. On Tuesday, the House has established a Special Committee to analyze one such proposal. On Wednesday, the committee appointed center-right representatives Hildo Rocha and Aguinaldo Ribeiro to act as chairman and rapporteur for the bill—a sign that lawmakers are trying to get things moving, even before the House finishes its analysis of the pension system.

Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Most recently, she worked as an Editor for Trading News, the information division from the TradersClub investor community.

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