Brazilian rally stalls - but still has some way to run

published 31 October 2005

After more than doubling in dollar terms in 2003, Brazilian equities have "run out of steam", says Frankfurter Allgemeine Zeitung. The Bovespa index slid by about 2% this year on concern that US interest rates could rise sooner than expected - dearer US money reduces the appeal of higher-yielding markets. But this should not be the main worry for investors. As JP Morgan points out, healthy trade balances - caused by the commodities upswing - have already made South America much less dependent on capital inflows than previously.

Of more concern is political instability. Since his election in late 2002, Brazil's left-wing President Lula has "thrilled worried investors" by adopting his predecessor's fiscal discipline, says Jonathan Wheatley in BusinessWeek. But now a campaign-finance scandal has tarnished his party's "squeaky-clean" image, forcing him into an alliance with "pork-barrel politicians" in another party. And rising public frustration over the lacklustre economy (it grew just 0.2% last year, but is forecast to recover by 3% in 2004) has also fuelled demands for Lula "to make a lurch towards populism". That would undermine stability and growth.

On the plus side, the market, on a forward p/e of 8.2, is cheaper than many of its peers and this year's economic recovery could surprise on the upside, says Mario Epelbaum of Morgan Stanley. Healthy industrial production and signs of rebounding investment spending and strengthening consumption points to "robust" growth. And if hitherto sceptical local investors (who sold for most of 2003, even as foreign inflows remained strong) can be enticed back into the market by the improving outlook, they will be a "catalyst" for further gains.

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