The prospect of an impeachment for Brazilian President Dilma Rousseff — which the Brazilian senate was expected to vote on this evening — looks like the sort of wrenching experience that could derail the Brazilian stock market’s four-month rally.
But don’t count on it. Brazilian stocks have priced in the prospect of impeachment over the past several months, says Steve Cordasco, CEO of Cordasco Financial Network and a manager of the $34 million West Shore Real Return (IWSFX).
The country and its stock market still face tough times. Brazil is mired in its worst recession since the 1930s, according to UBS economists. That downturn has been fed by a toxic cocktail of collapsing commodities, rampant political corruption and missteps in economic micromanagement. Now the country is also feeling homestretch pressure to complete costly Olympic venues and run a safe and successful event.
But global commodity prices overall have had — and will continue to have — a much bigger impact on Brazil’s economy and securities prices than Rousseff’s twisting in the wind, Cordasco adds.
Removal of Rousseff could even clear the way for Brazilian assets to rally further, says J.J. Feldman, portfolio manager at Miracle Mile Advisors, based in Los Angeles.
“She’s been mired in scandal,” he said. “She can’t pass legislation. This scandal has made her ineffective. So if someone comes in — like the vice president — and can deal with the issues; is more business oriented; does not take on more debt, making things worse; that could definitely improve the situation. But it is to be determined how all of this plays out.”
Feldman’s clients have exposure to Brazil mainly through iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV), which has a 1.5% weighting in Brazil.
But Brazil faces a tough road whether or not Rousseff is impeached, says William Pruett, manager of $533 million Fidelity Latin America Fund (FLATX). If a successor — Brazilian Vice President Michel Temer is likely to take the reins until November — tackles reform of taxes, tariffs and the national pension program, the short-term result would be higher taxes, more foreign competition and less spending power for consumers. “Those things would be negative for GDP,” Pruett said.
His fund had a 43% Brazil weighting as of March 31.
Instead of focusing on political tides, Pruett is focusing on what he calls great companies with cheap valuations. “Most of the opportunities I see are in nonbank financials and domestic discretionary stocks and domestic industrials,” he said. “Several are quite cheap.”
As of his latest disclosure, holdings that illustrate his preferences include Cielo. He said, “It’s technically an IT company, but I see it as a nonbank financial. They are a credit-card processor.”
Another is Kroton Educacional. “They’re a for-profit education company,” he said.
Yet another is Qualicorp. “They’re an insurance broker, so they’re another nonbank financial,” he said.
He also cites Smiles. “They’re an airline loyalty program operator,” he said. “They’re a combination of nonbank financial and company geared toward domestic air travel.”
Some of the optimism about Brazilian commodities stocks has been driven recently by the broad investor outlook for China. “It’s about people getting excited about China again, and I have my doubts about whether that is sustainable.”
Verena Wachnitz, manager of $572 million T. Rowe Price Latin America Fund (PRLAX), said in April: “Investor sentiment toward Brazil has already improved over the last few weeks as the probability of impeachment has risen. A confirmation of this process will likely improve sentiment further. Over the last five years, (Rousseff) has been the driver of policies that have ultimately been destructive for the Brazilian economy and damaging for the fiscal and debt dynamics. The possibility of a change in government would at least be a first step in changing policy direction.”
Wachnitz said banks are among the most attractive opportunities in Brazil. “We still see good upside for our key holdings in Brazil, with our focus on high-quality companies that are able to manage through a difficult environment and emerge more strongly,” she said. “Our preference would be for the private-sector banks, shopping malls and high-quality consumer names. If we have a new government direction that succeeds in bringing down inflation expectations and addresses the medium-term fiscal and debt dynamics, this would be a positive environment for Brazilian assets.”
Wachnitz provided names she likes. “One example would be in the private-sector banks, for example Itau Unibanco Holdings, which has had conservative lending practices over the last five years and therefore a manageable risk in terms of NPLs (nonperforming loans), while also having a strong balance-sheet position to benefit from pent-up demand returning when the economy returns to growth,” she said.
She added, “In the retail sector one of our larger positions is in Lojas Renner, an apparel retailer, which has been very successfully navigating the difficulties faced by Brazilian consumers. Helped by their investments in their distribution capabilities, they continue to pose sales results well ahead of the sector.”
Political change would help Brazil’s commodities sector the most, Wachnitz says.
“Commodities are a pretty important source of income for Brazil,” she said. “When you map out growth during the supercycle, it maps out pretty well with the country’s terms of trade. There are a lot of ways commodity prices helped Brazil. They have contributed to the growth in employment. They have also contributed to the fiscal accounts and government spending, since much of the tax base comes from consumption and income-based taxes. Third, it also relieved the external constraint in that with booming exports, a consumption boom could go on without busting the current account deficit. And, keep in mind that with rising commodity prices and exports came rising FDI (foreign direct investment) and more portfolio flows in commodity sectors. So, the commodity sector was a levered one.”
But she does not expect a commodity rally. “(S)ince we know that’s not going to happen, Brazil has to do the hard work of improving infrastructure, reforming labor and education, (and) reducing red tape and (taxes),” she said. “It has to be more open to trade, consolidate its fiscal policies and implement many productivity-enhancing measures to compensate for the fact that the commodity boom is behind them.”
Miracle Mile’s Feldman said: “The presidential situation is already priced into the Brazilian market. Their senate action will not be a market mover, in my view.” Brazil was hurt by the global slump in commodity prices. But those have rallied this year. And so have Brazilian securities. IShares MSCI Brazil Capped ETF (EWZ), which plunged 41.74% in 2015, is up 40.14% so far this year.
A softer U.S. dollar makes it easier for Brazil to pay foreign debts, Feldman says. It also slows inflation, and this makes life economically easier for Brazilian consumers.
Financial services are EWZ’s biggest sector, with a 34% weighting, according to Morningstar Inc. Consumer defensive stocks are next, with a 19% weighting. Energy is the only other sector with a double-digit weighting, at 12%.
The fund’s five biggest stocks are Itau Unibanco, AmBev, Bank Bradesco, Petroleo Brasileiro (Petrobras) and Cielo.