Brazil’s stock market rises from the dead. What now?

. Jun 17, 2020
Brazil's stock market rises from the dead. What now_ Image: Osorio Artist/Shutterstock

While economists debate on the shape that the post-pandemic economic recovery will take, there is one aspect where all signs point to an ideal V: Brazil’s stock market. In the first month of the pandemic, Brazil’s benchmark stock index Ibovespa fell by half, but has already clawed its way back to around 90,000 points, 20-percent below its all-time high — buoyant figures considering the magnitude of the pandemic. Volatility continues, but investors are measuring the fundamentals behind this rebound.

Looking at the most recent data about the real economy in Brazil, such as the worst drop in retail sales and industrial output on record, or the grim GDP projections — with contractions potentially reaching up to

9 percent, depending on the variables factored in — the stock market’s swift recovery seems disconnected to the current scorched-earth scenario. But local fund managers heard by <strong>The Brazilian Report</strong> warn that the full picture is more complex than the immediate profit perspectives for Brazilian companies — which are definitely poor in the short term — and involve Covid-19 developments, bargain purchases, excess liquidity, and global trends.</p> <p>To understand Ibovespa’s almost miraculous recovery, first we need to take a step back.&nbsp;</p> <p>During the worst moment of the crisis yet, between March and April, Brazil&#8217;s stock exchange was among the worst performers in the world, a freefall that was even steeper in USD due to the devaluation of the Brazilian currency. But even as markets <a href="">recover worldwide</a>, the bounce in Brazil seems to be more timid than in the U.S., where Nasdaq has already hit all-time highs despite the poor economic prognosis.</p> <p>According to Patrick O’Grady, chief executive officer at asset management firm Vitreo, the numbers show that Ibovespa has been following a global pattern. But he also adds that, while indexes are used as a general measuring stick for stock markets, they do not necessarily represent the performance of <em>all </em>stocks, nor the real economy.</p> <p>&#8220;This difference between the indexes and companies&#8217; market caps is because fewer companies have increasingly larger stakes in them. If you analyze the S&amp;P 500 with and without tech companies, it is a totally different thing. And Ibovespa has always been even less diversified than that. It is also not a good snapshot of the economy&#8217;s performance, as it unites only the country&#8217;s strongest players,&#8221; he told<strong> The Brazilian Report</strong>. Small, non-listed companies account for <a href="">99 percent of all businesses</a> in Brazil.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/2867726" data-url=""><script src=""></script></div> <p>News of progress towards a Covid-19 vaccine, success in treatments with new drugs — such as dexamethasone —&nbsp;and the fact that Europe has yet to experience a second wave of coronavirus infections are seen as major mood boosters for investors. But the volatility caused by the news that Beijing is closing schools once more due to a spike in cases is a reminder that these hopes are still fragile — not to mention the fact that Brazil is the world&#8217;s new Covid-19 epicenter.&nbsp;</p> <p>So what else is stirring this appetite for risk in big Brazilian companies?</p> <h2>The money has to go somewhere&nbsp;</h2> <p>It is important to keep in mind that, despite the massive capital destruction caused by the plunge in stocks, liquidity is on the rise, as Central Banks and governments from all over the world pumped unprecedented amounts of money into the system to keep the lights on. In the U.S., even after trillions of dollars in aid and a massive corporate bond purchase program, the Donald Trump administration is considering a new USD 1-trillion infrastructure investment package, helping to boost foreign investors&#8217; hopes.&nbsp;</p> <p>Data such as 17.7 percent growth in U.S. retail sales in last month also help strengthen the vision of a quicker recovery in the world’s largest market.</p> <p>In Brazil, for the first time on record, the Central Bank has dealt with a crisis by <em>lowering</em> its benchmark interest rate, among other measures to release what could ultimately amount to BRL 1.2 trillion (USD 230 billion) in the economy. Also, the bank&#8217;s Monetary Policy Committee is expected to slash rates even further, from 3 percent to 2.25 percent on June 17.</p> <p>For Mr. O’Grady, such levels of government support also foster the appetite for risk. “Stock prices are improving as a reflex of this monetary and fiscal help that is being granted all over the world. Investors think ‘if the economic output is weak, there are the Central Banks and National Treasuries to provide support. On the other hand, if it improves faster, I also win.&#8217;”</p> <p>Plus, the increasingly lower returns on safer assets explains why from January to May, withdrawals in fixed-income funds reached BRL 131 billion, while stocks funds had a positive influx of BRL 48.4 billion, according to <a href="">data by fund industry association Anbima</a>.</p> <p>“With the high global liquidity and the drop in interest rates, many investors do not have anywhere to put their money, so you see a clear migration from fixed-income assets to riskier assets, as well as the increase in the interest of individual investors,” says Gustavo Akamine, a fundamentals analyst and fund manager at Constância Investimentos. </p> <p>Notwithstanding, roughly BRL 2.4 trillion remain allocated in fixed-income funds dangerously approaching near zero returns, when considering inflation and performance fees. Not to mention another <a href="">BRL 1 trillion in savings accounts</a>, generating returns 30 percent below the benchmark interest rate.</p> <p>“When the interest rates drop on a structural level, you reduce the cost of opportunities, and this justifies investing in stocks. We see the opportunity of investing in stocks is still attractive, considering other investments,” said Marco Harbich, an strategist at Terra Investimentos.&nbsp;</p> <h2>Uneven recovery&nbsp;</h2> <p>With 47 percent in gains since hitting rock bottom on March 23, Ibovespa is no longer an obvious bargain. Stock prices of major companies — such as mining giant Vale — have already recovered to pre-crisis levels, while retailers with positive perspectives towards e-commerce — such as B2W, Via Varejo, and Magazine Luiza — have registered double-digit gains on a year-to-date basis.</p> <p>For Gauss Capital’s partner Jorge Junqueira, e-commerce was the first to respond to the rebound, but now it is time to look at the companies “whose world people thought it would come to an end,” he says, quoting sectors such as higher education or shopping malls as possible opportunities. “People were extreme in saying that no one would study anymore, but we think that well structured companies have the ability to establish a stronger online learning presence,” he told <strong>The Brazilian Report, </strong>quoting education company Cogna as one of the fund’s positions.</p> <p>Mr. Harbich also points out that Brazilian listed companies are the strongest candidates to gain market share among a move toward consolidation expected to happen amid the recession. And, among those, companies that managed to fundraise in pre-crisis initial public offerings or through<a href=""> follow-on offers</a> are in a more comfortable position.</p> <p>Even stocks that were severely punished, such as airlines Gol and Azul and travel agency CVC, have registered triple digit gains since the worst moments of the crisis, according to consultancy Economatica.</p> <p>Mr. O’Grady points out that while this seems a natural recovery move, the sectors that suffered the worst losses are also the ones with the biggest uncertainties in the long term. “We still don’t know how long it will take for people to travel and consume entertainment like they did before. It would be hard for me to recommend companies with higher uncertainty levels with Ibovespa nearing 100,000 points,” he says, adding that he wouldn’t rule out a portfolio with Brazilian stocks, but the current moment requires a higher level of selectivity.&nbsp;</p> <h2>Long term concerns for the stock market</h2> <p>Brazilian assets&#8217; steep volatility is also connected with the country’s particularities, largely its political landscape. As Mr. Akamine explains, the political shocks of the past months had a hand in the devaluation of the currency and prompted a spike in the level of Credit Default Swaps, which is a measure of a country’s ability to honor its sovereign debt.</p> <p>The increase in the government spending to fight Covid-19 — which may push gross public debt <a href="">to over 100 percent of GDP</a> — is perceived as one of the major risks in the long term, even though the country still has hefty USD reserves to cushion this blow, as highlighted by Mr. Junqueira.</p> <p>Unsurprisingly, news of the <a href="">imminent exit of Secretary of Treasury Mansueto Almeida</a>, one of the strongest supporters of fiscal austerity among the economic team, rattled the market. On June 16, the USD ended the day at its <a href=";utm_medium=social-media&amp;utm_content=geral&amp;utm_campaign=economia">highest level against the Brazilian Real since June 1</a>, at BRL 5.23.</p> <p>Now, says Mr. Akamine, “any long term thesis will depend a lot on reforms and the government’s ability to negotiate their approval. We also have municipal elections and the election of the new House Speaker on the radar. But if the government is able to approve the reforms, there is an upside.”</p> <p>Whether the administration is capable, however, is not clear in Mr. O’Grady’s view. “The political crisis forced the president to search for governability, but it’s not clear whether he’ll be able to move forward with the reforms, which are cornerstones to attract investments,” he said, adding that for long-term foreign investors, the country is still an unattractive prospect.

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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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