Why we still like Brazil

Well, that was a disappointment.

We had been hoping that Brazil would elect the pro-business candidate, Aecio Neves, in the presidential election at the weekend.

But sadly, while the final result was close, the left-wing incumbent, Dilma Rousseff, managed to hold onto her job. As a result, the Brazilian market and currency have fallen, while the interest rates on bonds have gone up.

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However, we still think that there's value to be found in the world's seventh-largest economy. What's more, one of the companies that looks particularly interesting is the state oil company itself.

Brazil's problems

It's clear that Brazil faces three main problems.

The most immediate is the bear market in commodities. As the Chinese economy has slowed, the price of metals, such as copper and iron ore, have slid. The US fracking boom has also meant that the oil price has also begun to fall. Even food prices have felt downward pressure.

This is a serious issue, because commodity exports account for half of Brazil's exports. Agriculture alone accounts for about 15% of the workforce (though this is down from nearly 25% in 1999). As a result, growth is expected to be only 0.3% this year and 1.2% in 2015.

There are also some structural problems. The first challenge is getting public spending under control. One of the reasons why Rousseff managed to grind out a win was her generous welfare spending. However, this has come at the cost of a government deficit of around 4% of GDP, high taxes, and inflation that is nearly 7%.

Another longer-term problem is the lack of infrastructure. Despite some investment in the past few years, Brazil's roads, railways and airports are some of the worst in the world. Most experts agree that this is acting as a major break on growth. While last year's World Cup went off without a hitch, there are still huge concerns about preparations for the 2016 Olympics.

Dilma's challenge

The consensus view is that Rousseff is going to struggle with the task of turning around Brazil's economy. For instance, Neal Shearing of Capital Economics thinks that to cut taxes and spending, she will have to go against the coalition that got her re-elected. Overall he expects that it will be a "tall order" to carry out change, making "more of the same" the most likely outcome.

However, we're not so sure. To be facing political death, not once but twice, is likely to have a sobering effect. We tend to agree with Kunal Ghosh, who runs the Bric Stars Fund that the experience "will act as a wake-up call". Now that Rousseff has been elected, she can spend political capital on reforms that might be unpopular in the short run, but will boost growth further out.

Even as the results started to come in there were some positive signs, with Rousseff seeming to admit that reforms were needed. Indeed, in her victory speech she admitted that there were shortcomings in her first term in office.

Putting words into action

Rousseff will have a chance very soon to put her words into action, as she has already said that finance minister Guido Mantega will step down in December. His replacement is likely to take a tougher line on waste. Indeed, some think that Rousseff may make a bold gesture by appointing someone from another political party to take Mantega's place.

What's more, Brazil's infrastructure problems are being slowly tackled. And the state bank has also been aggressively lending to construction firms, dispensing $85bn in infrastructure-related loans. These loans are set at low rates to encourage investment.

How to invest in Brazil

So, should you invest in Brazil?

According to Mebane Faber, Brazil was one of the cheaper markets back in July, with a Cape of just above ten (Cape' stands for cyclically-adjusted price earnings ratio). As a point of reference, the UK and US have Capes of 14 and 16 respectively.

Since July, Brazil's stockmarket has fallen by 20%, so it should be even better value now. We certainly think it is a risk worth taking though we wouldn't put all of our money into it.

As for funds, we like the iShares MSCI Brazil UCITS ETF (LSE: IBZL). While it does have a total expense ratio (TER) of 0.74%, which is high for a passive fund, it is the easiest way to buy in to the whole market.

If you'd prefer to buy an individual stock instead, we'd tip Petrobas (NYSE: PBR). Admittedly, the shares have been hit by a corruption scandal, but on a price/earnings ratio of 7.5 and a huge discount to net assets, it is a bargain if you believe that Rousseff will carry out reforms (as I do).

Finally, if you are interested in Latin America, you might want to subscribe to our free emailThe New World. It's co-written by Latin American expert James McKeigue. James spends a lot of his time flying around the region interviewing key movers and shakers to find out what's really going on, and to find the best bargains.

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