Brazil looks a great investment – and a half-decent government would make it even better
Brazil could soon have a pro-business government. That's great news for investors. But whoever wins the election, there are plenty of reasons to invest there, says Ed Bowsher.
The Brazilian stock market jumped by 5% yesterday.
Why the good cheer? Because investors were pleasantly surprised by the election result.
This was the first-round vote for Brazil's presidency. We now know that the final face-off will be between the left-wing incumbent, Dilma Rousseff, and the centre-right candidate, Aecio Neves.
The surprise was that most observers had expected Rousseff to be up against a different candidate the centrist Marina Silva.
There's now a chance that Brazil could soon have a pro-business president rather than the somewhat inept Rousseff hence the market rally.
So can Neves win? And whatever happens, is now a good time to invest in Brazil?
Brazil's stockmarket is still well below its 2010 peak
Even after yesterday's rise, Brazil's main stock market index, the Bovespa, is still more than 20% below its peak in 2010. There are three main reasons for that.
Firstly, there's the expectation of higher interest rates in the US. Some American investors have already brought money home' from emerging markets such as Brazil in anticipation of rates rising. In short, if you can get a decent return on your money in the US, why take the risk of investing in emerging markets?
Secondly, concerns about China's financial stability have hit Brazil, as Brazil is a big exporter to Asia.
And finally, the most important reason Brazil just hasn't been very well governed since Rousseff took power in 2011. Rousseff tried to stimulate growth by pumping up government spending and raising the minimum wage. She also forced state-run banks to lend more.
As a result, inflation took off. Rather than reverse course, she imposed price controls, which inevitably make things worse by creating shortages. Inflation now stands at 6.5%, while GDP shrunk in both 2012 and 2013.
It's no surprise that civil unrest erupted in Brazil last year, as middle-class Brazilians protested against falling living standards. They were also angry about widespread corruption another issue that has held the Brazilian economy back. On top of all that, Brazil's infrastructure, both for transport and electricity, is under-developed.
So what's the good news?
However, there are some good reasons to consider investing in Brazil. And these apply regardless of who wins the second round of the election.
For starters, Brazil has been a democracy for almost 30 years now, and that doesn't look likely to change. And just like India, demographics look good. The average age for the population is 29, much younger than the US, where the average age is 39.
Brazil also has significant oil reserves, along with masses of agricultural land. As the global population continues to soar, the value of this land must surely rise.
Brazil also looks pretty attractive on valuation grounds. The stock market currently trades on a price/earnings ratioof 17, which isn't bad, and the dividend yieldis over 4%, which I think is fantastic for a market with lots of long-term growth potential.
And if you look at Brazil's Cape (cyclically adjusted price earnings),Brazil looks cheap with a rating of just ten, according to Mebane Faber. (Faber calculated this Cape figure back in July, but the stock market was then at roughly the same level as now, so his Cape figure for Brazil shouldn't be too far off now.)
Then of course, there's the possibility that Neves might win the second round. If he does win that round, I'm in little doubt that the stock market will rise further (look at what happened in India when that country elected a pro-business president).
Let's be clear, Neves was a long way behind Rousseff in Sunday's poll. Rousseff got 42% of the vote while Neves got 34%. However, some observers think Neves will be able to win over the majority of the centrist Silva's supporters, who comprised 21% of voters.
For example, Tony Volpon from Nomura told Fast FT that the "result suggests Neves did well to build momentum, especially on a very strong debate performance last Thursday. To win the election he will need to convert around 70% of those who voted for Marina Silva which we believe is possible.
"Momentum aside, Neves has so far run an effective campaign and has resources and a powerful party machine to support his final push. Further, Silva positioned herself very strongly against Rousseff during the campaign, which, in our view, means her supporters are still likely to vote against the incumbent. This is made all the more likely as we believe Silva will formally endorse Neves."
How to invest in Brazil
My hunch is that Neves will just shade it. But I wouldn't base your investment decision on this. There's too much uncertainty for that. So this isn't a short-term speculative punt. If Rousseff wins, markets could well express their disappointment.
Even so, I think Brazil will prove to be a decent investment for the long term the population and the agricultural land will see to that. So if you do decide to invest for the long term, the cheapest option is probably the iShares MSCI Brazil Fund (LSE: IBZL) which has a total expense ratio (TER)of 0.74% a year.
However, I'm not convinced that passive exchange-traded funds are the best way to go with a relatively immature stock market such as Brazil's, so I'm more attracted to the actively-managed JP Morgan Brazil investment trust (LSE: JPB), which has a TER of 1.47% and trades on an 8% discount.
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