Last updated: 08:46 / Monday, 12 May 2014
ARX Investimentos, BNY Mellon

The Major Headwinds Facing Brazilian Equities

The Major Headwinds Facing Brazilian Equities
  • All eyes are on Brazilian elections and the coming soccer World Cup
  • Manager of the BNY Mellon Brazil Equity fund Rogerio Poppe, discusses the numerous headwinds facing investors in the country

With elections looming in October, approval ratings for President Dilma Rousseff’s government have been touching new lows. At 36 per cent in March – down from 43 per cent at the end of 2013[1] – it is reaching a critical level. However, with an opposition lacking in substance, Rogerio Poppe, portfolio manager at BNY Mellon’s investment boutique, ARX Investimentos, explains why there is a high chance re-election could be achieved. What’s more, he says there’s a great risk of much-needed economic reform being dodged.

All is not rosy in Brazil. Inflation is high and vast swathes of the electorate feel out of touch and ignored. Much of Dilma’s focus during her time in office has been on social assistance through programmes such as Bolsa Família, a social welfare platform implemented by her predecessor, President Luiz Inácio Lula da Silva, which provides financial aid to poor Brazilian families.

While the success of Bolsa Família can’t be ignored – around 11 million Brazilian families benefit[2] – it has had its fair share of critics who cite the problems of benefit addiction and the programme acting as a source of discouragement from work. The programme may well help around a quarter of the population but for the remaining 75 per cent, the overriding concern is inflation and the rising cost of living in the country’s major cities. Some 85 per cent of the population lives in urban areas[3].

Meanwhile, there are significant public transport limitations and Brazil remains some way behind the rest of the world when it comes to infrastructure spending. According to The Economist, Brazil invests just 2.2 per cent of its GDP in infrastructure, well below the developing-world average of 5.1 per cent.

The global stage

The Brazilian people grabbed the attention of the developed world during last year’s Confederations Cup, the traditional pre-cursor to the soccer World Cup, as millions took to the streets of Brazil’s cities to demonstrate against the government’s failures.

“This year’s World Cup is likely to prompt further unrest but we don’t expect it to be on the same scale as 2013,” said Poppe, who runs the BNY Mellon Brazil Equity Fund.

“Last year’s troubles were caused by a minority; peaceful protest had been the general intention.”

“What’s more, let’s not forget that this is Brazil and the World Cup we are talking about – never underestimate the draw and importance of football to the Brazilian psyche. Righting the wrongs of 1950 – the last time Brazil hosted the World Cup it lost the final to Uruguay – will do much to preoccupy the electorate,” he added.

Regardless of the widespread protests, Dilma has done little, if anything, to address the underlying concerns of the Brazilian people, according to Poppe; indeed, inflation continues to exasperate these problems.

“The effects of inflation will only get worse as areas in which the government has frozen prices, such as fuel, are unfrozen,” he explained.

“At the same time, fuel price freezes have severely hampered the ability of largely state-owned companies, such as Petrobras, to thrive. That the weakness in her approval ratings has corresponded with strength in the domestic stock market is no coincidence.”

“Dilma’s administration has limited the value of these companies by using them as a political lever. It is a similar story with the state-owned banks; used as a tool for cheaper credit availability, there is a need for significant capital raising within the banking system over the next five years.”

A period of sustained economic stagnation is the likely result, he says.

Challenged challengers

But what of the opposition to Dilma’s Workers’ Party?

“This is the crux of the problem – there is little opposition of substance,” said Poppe.

The major opposition party, the Party of Brazilian Social Democracy (PSDB), is yet to announce its candidate to run against Dilma. Aécio Neves is widely expected to be PSDB’s ‘man’ but uncertainty prevails.

What’s more, the party has long been dogged by internal wrangling and has also recently been the subject of an investigation into alleged corruption in the São Paulo state government, which it has run since the mid-1990s.

“Uncertainty abounds when it comes to the major opposition’s policies, too; inflation aside, there has been little detail forthcoming,” Poppe added.

A change of government seems a long shot but, at the very least, Brazil needs a change in government. Poppe says this seems unlikely, however.

“We believe Dilma’s re-election would be a negative for the Brazilian economy over the next decade,” he warned.

“The economic fundamentals are still very good, despite the recent Standard and Poor’s downgrade; indeed, the country is in ruder health than many European economies. Yet the problem remains the direction taken by the incumbent government – the current economic policy is a limiter on growth.”

“Ultimately, Brazil needs to follow the trail blazed by Mexico and implement far-reaching and achievable reforms. Given the scale of the Brazilian market, it too should be attracting huge investment – sadly, though, this is no longer the case.”

A Dilma re-election would usher in no change, according to Poppe.

“She vehemently believes in what she is doing – she is a lady not for turning.”

The result? An economy saddled with inflation, a depreciating currency, an inability to attract external investment and the prospect of low growth over the coming years.

Latin America’s great hope is facing a tough near-term future. Seleção glory this summer might prompt a short-term bounce but once the celebrations die down, the bleak reality will be felt once again.

[1]National Industry Confederation, March 2014

[2]The World Bank, April 2014

[3]The World Bank, December 2013