By Jorge Amato
Head - Latin America Investment Strategy
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How we are positioning portfolios for the upcoming Brazilian elections
Brazilian politics are about to enter a crucial stage as campaigning begins soon. At stake are general elections which are scheduled for a first round on October 7th and 2nd round on October 28th.
Brazilian voters will elect a new President and Vice-President as well as members of the National Congress, State and Federal District governors and vice governors, states Legislative Assemblies and Federal District Legislative Chamber.
At the moment ex-president Lula is the official candidate for the PT (Workers’ Party) and is leading in the polls. However, we believe there is a high likelihood that the TSE (electoral court) will rule him ineligible to run as suggested by the “Ficha Limpa” (clean record) law which bars candidates whose convictions have been upheld by an appeals court. Lula is currently serving a 12-year sentence after being convicted of money laundering and corruption. If he is barred from running, the PT would have until September 17th to announce a final candidate – which could be his current choice of Vice-President, Fernando Haddad.
Without Lula (>80% probability in our view) polls show the race is currently led by Jair Bolsonaro followed by Marina Silva, Ciro Gomes and Geraldo Alckmin. However, investors should account for a new PT candidate to be announced if Lula is barred, making the current polls less accurate.
Recent backing for Alckmin from center right parties suggests that we should see his current 4th place in the polls improve in the coming months as he will be allotted about 50% of the official media campaign time – versus estimates of low single digit exposure for Bolsonaro, Marina and Ciro and possibly around 20% for an undefined PT candidate if Lula can’t run.
With the potential for undecided voters to be as high as 30%, the lack of a clear statistical lead by Bolsonaro over Marina, the uncertainty over the definitive PT candidate and with the whole television and radio campaigning ahead, making a high conviction prediction at this stage is extremely difficult.
Achieving a long term fiscally sustainable framework is the main challenge. The monetary side of the equation is under the control of a credible Central Bank, providing a necessary but not sufficient condition.
No matter who wins the October elections, the next president will have to tackle structural reforms that currently stifle economic activity and prevent long term economic growth. We will continue to closely follow the campaign to try to better assess medium term scenarios but for the moment the balance of risks between fundamentals and valuations suggest we should remain overweight in our balanced portfolios.
In the meantime, and as the campaigning starts, speculative opportunities are likely to arise as volatility rises and assets become subject to under/over shootings of their market prices relative to fundamental valuations. Home biased investors, who are likely overexposed to Brazil risk, are the most vulnerable to volatility and should hedge or manage exposure actively.
The Brazilian currency (BRL) is likely to act as the escape valve for higher uncertainty, impacting along the way the value of local rates and equity positions measured in USD. We don’t believe the BRL is fundamentally overvalued and the futures positioning on the currency shows a large short speculative base; both factors provide support against downside risk. However, Brazilian equities and bonds have rallied over the last few weeks, suggesting that the June lows could easily be re-tested under high levels of political uncertainty.