RIO DE JANEIRO, BRAZIL – In line with what large international institutions have been doing, Credit Suisse reduced its exposure to Brazilian equities from overweight (exposure above the market average) to benchmark (or in line, equivalent to the neutral recommendation), while Mexico was raised to overweight.
Among the reasons for the reduced exposure to Brazil are political concerns, the fiscal scenario, and the impact of Covid-19 on economic activity.
With respect to the first point, strategists point out that the main driver for the reduction in the price outlook on earnings was the perception of worsening corporate governance of companies with the replacement of Roberto Castello Branco by ex-General Joaquim Luna e Silva at the presidency of Petrobras, followed by President Bolsonaro’s statement that the state controlled companies should “address social issues.”
Strategists also point out that ex-President Lula recently had his convictions overturned in the courts, potentially opening a path to run against Jair Bolsonaro in 2022 (although the Prosecutor General’s Office appeal could still result in this decision being overturned).
“If Lula runs and wins, he would probably delay the more liberal political agenda in Brazil, and even if he doesn’t win, we think his presence in the electoral arena could push Bolsonaro further away from fiscal orthodoxy,” they assess.
They also point out that, with the mismanagement of the Covid-19 crisis – a Datafolha poll on March 16th found that 54% of Brazilians disapproved of the way he handled the crisis – Bolsonaro could come under great pressure from the left.
On the fiscal picture, strategists point out that Brazil has real GDP growth (up 0.2% between 2010 and 2019) below the real yield on bonds (3.5%, in reference to Brazil’s inflation-protected 10-year yield), as well as much higher debt compared to other emerging countries. In addition, Brazil has also spent more than any other major emerging country on emergency programs. While this has brought some relief to economic activity, it has also resulted in a larger fiscal deficit.
The third and final point is that Brazil is in one of the worst moments with increasing rates of pandemic coronavirus infections today (with new cases and deaths at record peaks).
With the chaos of still rising cases of Covid-19 with a deteriorating earnings review, the strategists highlighted two reasons for not having taken Brazil even lower, underweight (exposure below market average).
The first, because of the valuation of Brazil’s currency, the real, which still looks too cheap relative to export market share or balance of payments. In addition, the price to earnings ratio of the companies on the exchange still looks cheap relative to the rest of the world, both excluding commodity stocks and the market as a whole.
On the other hand, Mexico has had its exposure raised in the portfolio as the Mexican peso still looks cheap; strategists also point out that Mexican stocks have gotten cheaper relative to other emerging markets. In addition, it offers leveraged exposure to the growing U.S. economy and oil. Finally, Mexico is one of the few countries to emerge from the crisis with a good fiscal position.
This assessment is in line with that of other strategists, who have been changing their positions on Latin America. In addition to the prospect of growing exports and remittances driven by stimulus measures in the U.S., Mexico ran one of the most austere budgets in the world during the Covid-19 crisis.
“Mexico is best positioned for outperformance” in the region, Emy Shayo, equity strategist for Latin America at JPMorgan, said in a report this week. She raised Mexico’s stock to overweight (an above-average recommendation), citing the country’s strong fiscal position and expectations of stronger U.S. growth. Brazil was downgraded to neutral after about four years of an overweight recommendation.
Source: Infomoney