Last Sunday, Brazil held the first round of its Presidential Elections.
The results surprised markets positively because the opposition candidate, Flavio Bolsonaro, came in first, ahead of incumbent Lula da Silva, giving him an almost uncontested advantage for the second round. The expectations in the final weeks and days of the campaign favored Lula in the first round.
Brazilian equities reacted accordingly, with the EWZ up 13% in one week and plenty of US-traded ADRs up 20/30%.
This piece condenses some concise ideas about what could happen after the second round, during a most-likely Bolsonaro government, and what this means for the economy of Brazil, its equities, and their prices.
I believe my read on the issue is fairly contrarian. The core is plus ça change, plus c’est la même chose. That is, the most likely outcome in a fundamental sense is that nothing really changes structurally in Brazil, at least coming from the Presidency (other factors like commodity prices or interest rates can obviously change and have a disproportionate effect on the Brazilian economy).
On the other hand, the sentiment is very likely to get ‘hot’, believing that Bolsonaro is the second coming of Lee Kuan Yew, just like it happened with Bolsonaro’s father in 2019, Milei in Argentina in 2023/4, or with Macri in Argentina in 2016.
Understanding both trends- fundamentals not changing, sentiment getting really excited- is key to riding the hype wave but getting off on time if things get too expensive.
Besides the sentiment wave, I also link to articles in which I analyze the structural challenges and opportunities of the Brazilian economy in more detail, and also to the areas where I see the most opportunity, out of all the sectors I have covered.
Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. I may own or later purchase some of the stocks mentioned in this article.
The 2nd round
Let’s not eat dinner for lunch; Flavio Bolsonaro still has to win the second round, which will be held on October 25th. Politics is never deterministic; things can change.
Having said that, he is very likely to win because of polarization. There were not that many candidates to the left or center of Lula that could now migrate to him. In contrast, there were a few alternative right-wing candidates that competed for the same vote as Bolsonaro and will very likely migrate to him. This makes most analysts believe that Lula has already hit his ceiling, whereas Bolsonaro has only stepped on his floor.
The main factor potentially turning the tide in favor of Lula is reducing absenteeism. Brazil is still a large country, where political structures for mobilizing people to vote matter, particularly among the poor, where Lula has an advantage.
That being said, it is unlikely that 3 million people, the difference in favor of Bolsonaro in the first round, plus a couple more coming from alt-candidates migrating to him, will be found in rural or urban-backland pockets of Brazil to vote en masse for Lula.
What the election reveals about Brazilians
Nothing, in my opinion, besides the fact that they are frustrated with a fairly ineffective political system, just like most people in the West.
This is, I believe, where my view starts to get non-consensus.
Right-biased analysts will read the Bolsonaro victory as a “final recognition by the Brazilian people that market-oriented reforms are needed and that populism has to be extirpated from its root”. Left-biased analysts will see “the creeping influence of messianic evangelism and salvation doctrine on the Brazilian people”.
What I see is just regular frustrated people in the middle of the ideological continuum flipping to the side that is not in government. Nothing else, nothing more. The poles of the spectrum are ever more polarized, and the middle flips one election after the next.
Not getting excited about the narrative of a watershed change in people’s mentality is important because otherwise one will get surprised when those same people, frustrated under Bolsonaro, start to look to the PT with good eyes in a few years.
This same view is valid for Argentina, for the US, Colombia, etc. People are frustrated; people flip; don’t need to read much into it.
What will change in the economy’s fundamentals?
Again, not much, at least from what the Executive can do, and therefore the long-term reads about the Brazilian economy should not change much.
This middle portion of the phrase is the most important.
There are undercurrent trends in Brazil that are very positive for its economy. Rates are coming down. Several commodities are in what seems like a secular bull market in many respects. But these are not managed by the Executive.
In fact, in general, the Executive in Brazil has relatively little power.
Lula could not direct interest rates, which ended up driving the bulk (~ negative 9pp vs breakeven) of his fiscal deficit. He could not modify most of the budget without significant Congressional support, because most of Brazil’s more relevant expenses are literally written into the Constitution. He could have manoeuvred around it, for example by trying as much as possible not to run the machine hot in areas like minimum salary or complementary subsidies, and he decided not to, but in many areas his hands were tied.
After the election on Sunday, Bolsonaro’s party only controls about 25% of Congress, with another 25% for Lula. This means any reform will require the remaining 50%, known as the Center, in Brazil: a mix of regional and center-of-the-spectrum parties that move with the wind. As long as Bolsonaro is doing well in polls, they will follow him. After that, they will become more combative.
It is true, nonetheless, that a significant portion of the Center is actually right-leaning or outright right. In total, only the 25% for Lula can be considered left-oriented, and maybe another 25% purely center. This is helpful for reform, but these free atoms in the Chambers are not loyal to Bolsonaro, and can be contracted by lobbies or political conveniences. The enemies of free market reform are not only leftists and populists, but also powerful entrenched interests with a lot of firing power.
What’s more, to modify the Constitution, where most of the problems are written (above all the budget constraints), requires 60% of the chambers. Large reforms will take a long time and are probably not going to be sweeping modifications.
The warning from this section is: don’t get overhyped by narratives around structural reforms at the turn of the corner, and pay more attention to structural drivers like interest rates, the credit/delinquency cycle, and commodity prices.
I wrote two articles about the more structural challenges and opportunities in the Brazilian economy, in case you are interested:
This article covers problems related to labor availability, productivity growth, unemployment, and investment.
This one covers more about persistently high interest rates in Brazil, and the challenges they cause in the real economy, along with an analysis of the credit cycle the country is currently in.
The big driver: sentiment
Despite what I said above, I expect the first year or two of Bolsonaro’s government to be positive for equities, driven above all by sentiment.
Sentiment around Brazilian equities was dismal going into the elections. The country was on its way to become Venezuela, or so many believed, and equities were priced accordingly. There were many quality companies trading at MSD or HSD multiples.
Now things will flip to the other side, with Brazil on its way to Singapore and beyond.
If undercurrents like rates going down and high commodity prices remain in place, then the economy should also improve, further reinforcing the narrative that once things are done well, the path to growth is guaranteed.
The issue is not to get carried away if and when Brazilian assets start to require a premium versus similar markets and economies. We are far from that point though.
Where to look for opportunities
I wrote a whole lot about Brazilian companies. You can find all the articles in the Index (some of them are free).
I believe financial companies like XP and B3 should do fairly well in a context of positive inflows of capital into Brazilian equities.
Cheap as a catalyst is also a group that should benefit from changes in sentiment. In particular, I believe names in consumer discretionary should also benefit from rates going down. If you also add quality in terms of brand moat, Vulcabras and Alpargatas are nice candidates.
Besides them, leveraged companies should probably continue to benefit from lower rates, as well as residential property developers.
