The Local Flavor (#28) – I wouldn’t buy the Ibovespa right now

There have been two main drivers for the positive performance of Brazil’s equity market in the last couple of years or so.

The first one was the cyclical rebound the Brazilian economy has experimented in the period.

It is good news to see the economy starting to react after the disaster observed during Mrs. Roussef administration.

But it is important to emphasize the economy is far from entering a sustainable growth period.  

The second (and most important) driver for the positive stock market performance has been the long lasting high liquidity, low interest rates international environment that has exerted a strong positive influence on markets around the world.

Sooner rather than later, the influence of the global markets liquidity will decline, and investors will have to focus mainly on domestic drivers.

Looking at the scenario for Brazil’s macro scenario in the next couple of years, there are much stronger uncertainties than convictions.

Although I personally believe that at the end of the day a centrist, mildly reformer candidate will win the upcoming presidential election, this is far from certain.

If the election result scenario is dim, the post-election macro scenario is also dim.

The future composition of the Congress is another major uncertainty. A reformist President will have a lot of trouble to push forward a reforms agenda without the support of the Congress.

We know a newly elected President tends to have Congress support in the beginning of a new administration, which is excellent.

However, the reforms agenda is very long and will require at least 2 or 3 years of Congress hard work. The President support is likely to become gradually weaker as a controversial agenda is discussed in Congress.

After reading the paragraphs above, readers are likely to be thinking I am all negative on Brazilian equities.

I AM NOT !!!

I just think investors should search for specific opportunities rather than being exposed to a broader market portfolio such as the Ibovespa portfolio.

On a top down basis, there are two main reasons why I believe investors should have at least 20% of its portfolio invested in Brazilian equities:

1.      In the next 2 years I expect the cyclical economic growth rebound to continue. This cyclical rebound may become a sustainable recovery if the next Government manages to approve a reasonably aggressive reforms agenda, and

2.      Short term real interest rates will remain very low for the next two years. Long term real rates are still high but again, they are likely to decline if the market start to believe in the implementation of a reforms agenda.

Bottom-line: I would divide my conclusion in two comments:

a.      Stock picking is the right equity strategy for a public market equity portfolio and,

b.      For those with the adequate risk profile, and capacity to invest for the long term, being exposed to middle market private equity investments makes a lot of sense. This is the segment where significant value creation is more likely to be unleashed.