While moves to expand welfare spending has spooked markets, we are tactically neutral on Brazilian equities as a lot of negative news has already been priced in.

Julien Holtz & Luc Luyet, Pictet Wealth Management

Faced with plunging approval rates and looming elections, the Brazilian government of Jair Bolsonaro is currently pushing to significantly expand Bolsa Familia, a key welfare programme. The proposal as it currently stands is not compatible with the legally sanctioned spending cap, due to higher-than-expected court-ordered payments in 2022. A constitutional amendment has been proposed to restore fiscal space. This aims to cap 2022 payments and tweak the way the spending cap is calculated. Such manoeuvres have spooked markets by eroding the credibility of Brazil’s main fiscal anchor at a time of high budget deficits and skyrocketing inflation.

While Brazilian equities may appear extremely cheap at the moment, this discount shrinks (without disappearing entirely) after accounting for factors such as sectoral differences and earnings growth expectations. On a price-to-book basis, they actually trade broadly in line with their 15-year average. Are Brazilian equities cheap? Yes. Dirt cheap? No. Nonetheless, we acknowledge that significant negativity has already been priced in, be it on future earnings, inflation, politics or fiscal risks. Rate hikes have been largely discounted while inflation should moderate by year end.

We are adopting a tactically more neutral stance than before towards Brazilian equities in the short term given the significant pessimism reflected in recent price action. However, we are more downbeat from a strategic point of view, especially in USD terms. Its undervaluation coupled with the central bank’s hawkishness and an attractive carry, may provide some support to the Brazilian real in the short term. That said, the slowdown in China and high fiscal and political uncertainties suggest that real outperformance may not be sustained.