Foreign banks sharply increase exposure to Brazilian stocks in Latin American portfolios: is optimism back?

By Lara Rizério, Moneytimes

RIO DE JANEIRO, BRAZIL – Far from controlling the pandemic and having last week surpassed the sad mark of 500,000 deaths caused by the coronavirus, Brazil still has many challenges to overcome in order to tackle the disease and resume normal economic activity.

However, as vaccination is expected to accelerate – still lagging behind developed countries, with only 11% of the population vaccinated with two doses – and with indications of economic and corporate resilience, several foreign banks have increased their exposure to Brazil in their strategic portfolios for Latin America, but not without highlighting the risks on their radar.

In line with this trend, the accumulated balance of June through June 22, foreigners have a positive balance (between inflows and outflows) of R$14.22 (US$2.89) billion in funds at the B3 exchange, heading towards closing the month as the 3rd in foreign capital inflows. In the year to date, the positive balance stands at R$49.417 billion.

In the past two weeks, UBS, JPMorgan and Bank of America have raised exposure to Brazil in their Latin American portfolios to above the average in relation to other economies in the region (the so-called “overweight”, exposure above the market average).

BofA’s David Beker, Carlos Peyrelongue and Paula Andrea Soto, part of the American bank’s strategy and analysis team, highlighted the revision in their projections for the Brazilian GDP, from a rise of 3.4% to 5.2% in 2021, pointing out that there is still a positive bias. The previous exposure was marketweight (in line with the market average).

Next, JPMorgan also raised its exposure to overweight within the Latin America portfolio, after having reduced exposure to neutral in March this year.

According to JP’s strategy team, led by Emy Shayo, although the Federal Reserve has been slightly more aggressive than expected in signaling interest rate hikes in 2023 (which could disadvantage emerging markets), growth will likely continue to set the tone in the coming months. “This global dichotomy favors equities, emerging markets, [assets categorized as] value, commodities, and cyclicality,” he says.

Moreover, the potential for further upward revisions to the Brazilian economy is still possible, the strategists assess, as retail and services data came in better than expected in April despite mobility restrictions. “Higher growth helps boost earnings but, more importantly, should lead to upward earnings revisions.” And that backdrop also relies on the improved pace of Covid-19 vaccination in Brazil, the strategy team pointed out.

Swiss bank UBS also upgraded Brazil to overweight with positive revisions to GDP, fiscal improvement, a more positive vaccination prospect, the most favorable outlook for profit-taking among emerging economies, and attractive valuation. The bank’s economists’ GDP projection for 2021 rose from a high of 4.5% to 5.8%.

But in addition to more optimism with the national scenario itself, the prospect of increased risk in other countries in the region due to political turmoil has also favored the increased exposure in Brazil within the Latin America portfolio, alongside Mexico. Meanwhile, Chile, Colombia, and Peru have seen their share in strategic portfolios shrink.

BofA cut Chile’s exposure to “underweight” following the results of the constitutional and local elections in the country. Mexico had its recommendation maintained at “overweight”, and Colombia maintained its marketweight (exposure in line with the market average).

JPMorgan’s strategists zeroed their exposure to Peru, while Argentina’s Mercado Libre was reduced. In addition to Brazil, JP also has overweight exposure in Mexico, while having “in-line” exposure to Chile, and “underweight” exposure in Colombia and Peru.

For its part, UBS reduced Chile from “neutral” to “underweight” exposure due to increased political uncertainties ahead of the November 2021 presidential election, renewed mobility restrictions, expectations that profit growth may have peaked, and a less attractive valuation.

The bank’s strategists remained neutral for Peru: “although electoral and political uncertainties have risen substantially after leftist Pedro Castillo garnered the most votes in the presidential election [against right-winger Keiko Fujimori], the recent market sell-off suggests that many of these risks are priced in,” they point out. The bank kept its underweight position in Colombia given the growing social unrest.

Like the other two financial institutions, UBS maintained its overweight exposure to Mexico, “a major beneficiary of the U.S. economic recovery, with our economics team updating its 2021 GDP growth projection from 5.6% to 6.3%.” Profits dynamics have slowed somewhat, but UBS assesses it as temporary.

Cautious optimism, but improved

Although many of the portfolio revisions have also been prompted by a relative worsening in other countries, the increase in Brazil’s exposure is also due to the improved domestic scenario.

Fernando Ferreira, XP’s chief strategist and head of Research, and Caio Megale, XP’s chief economist, pointed out in a report foreigners’ perceptions about the country after a round of meetings with some overseas investors.

After a very pessimistic start of the year, the sentiment improved. However, there is no euphoria: the sentiment is still “cautiously optimistic,” the report signed by Ferreira points out.

Ferreira recalls that Brazil had the world’s worst stock market and currency performance in mid-February, also witnessing an approximate R$12 billion foreigner outflow from the country during the period when the second wave of the pandemic was showing clear acceleration, Brazil flirting with a spending cap breach with no signs of passing the 2021 budget (nor the emergency Proposed Constitutional Amendment), and the government starting to interfere in state-owned companies (Banco do Brasil, the departure of the CEO of Eletrobrás, and finally in Petrobras).

In addition, the scenario for Brazilian consumers looked very dire, with a combination of high inflation, low growth and the end of emergency aid. Meanwhile, reforms or privatizations seemed like a distant dream.

Since then, much has changed, and for the better, says the XP strategist.

“The government’s fiscal numbers have consistently improved, the economy has shown clear signs of recovery, leading to a major revision by the market which now expects growth above 5% for the year – and with an upward bias. Congress has again made progress in the discussion of reforms and privatizations – the Senate last Thursday passed the Provisional Measure for the Privatization of Eletrobras. The commodities cycle has also continued to improve, contributing positively to the Brazilian economy, in addition to helping bring the exchange rate back to the R$5 level and boosting the Brazilian stock market’s 36% represented by commodity-related companies,” he says.

On the other hand, the main doubts XP heard from investors were, in the following order: 1) the 2022 elections, 2) the short and long term fiscal scenario (there are improvements today, but what are the chances of it deteriorating again), 3) the expected path for the exchange rate and 4) which sectors to invest in at the moment – commodities, domestic, value or growth stocks?

“The doubts show that foreign investors are not yet going ‘all-in’ in Brazil, and several fears still persist regarding the future. This suggests that the strong flow that we have had so far in the stock market by foreigners was a reduction of the Brazilian underweight position, given that foreigners had been out of the country significantly for a few years,” Ferreira points out.

XP’s chief strategist recalls that in 2007 Brazil reached almost 20% weight in the Emerging Markets Index (MSCI). Today, this weight stands at 4.6%, making it the 6th most important country in the index, behind Hong Kong, Taiwan, South Korea, India, and China. The emerging markets index has become primarily an Asia-focused index in recent years, while Latin America has consistently lost ground – and in global investors’ portfolios as a consequence.

The perception of investors is that most of them are still pursuing a more defensive portfolio with exposure to high quality and growth companies, and with low exposure to the big sectors of the stock market, such as banking and commodities. Therefore, if these “large caps” continue to rise, the feeling is that there would be more flow to these sectors, due to investors’ low positioning there.

XP remains constructive with respect to Brazil and Brazilian assets. “We believe that acceleration of vaccination and the economy should continue to boost companies linked to the domestic sector, and lead to positive earnings revisions by the market. The commodities cycle – if it persists – should also continue to boost both these sectors and the economy as a whole, due to its large indirect effect. Furthermore, Brazilian assets still remain cheap, both in relation to their history and in relation to other countries (especially the stock market and the exchange rate),” Ferreira points out.

For XP’s chief strategist, the feeling – and the positioning – of investors is still far from euphoric and optimistic about Brazil. This suggests that there is more potential flow to come to Brazil if the macro and micro scenario continues to improve.

JPMorgan, reinforcing greater optimism, raised its projection for the Ibovespa index from 134,000 to 140,000 points by the end of 2021 – or a 9% increase from the previous day’s close. Among the risks on the radar, the strategists pointed out the normalization of monetary policy in the world – including Brazil – in addition to the political scenario, with emphasis on the elections.

Stocks in focus

With an overall more optimistic outlook for Brazil, the strategists also highlighted which stocks they see as winners in an economic reopening scenario with an increase in the pace of vaccination and, consequently, an acceleration in activity.

Regarding the standout sectors, JP pointed out a preference for financial and commodities. “Earnings are up, earnings revisions are up, and multiples are down. It is true that it is due to financial and commodities, but that is exactly where we are increasing Brazil exposure in our model portfolio,” the bank pointed out.

In the portfolio for Latin America, BofA strategists added Natura (NTCO3) shares, which were already in the Brazil portfolio. In addition, they raised exposure to large banks already in the portfolio, such as Itaú (ITUB4), Bradesco (BBDC4), and also Banco do Brasil (BBAS3) due to signs of macroeconomic recovery, improving earnings dynamics, cheap valuation, and below-market performance since the start of the pandemic. “Although reopening and bank cases have largely recovered in the past month, they continue to lag behind compared to stock prices at the start of the pandemic,” they assess.

On the other hand, they remain more cautious on sectors such as services, airlines, and shopping malls. They also added exposure to Brazil’s economic recovery through Energisa (ENGI11) and removed BRF (BRFS3) after the recent strong rise.

Beker, Peyrelongue and Paula also say they continue to like inflation-related businesses as the world reopens, such as commodities, Hypera (HYPE3) and Carrefour (CRFB3).

In addition, they have maintained allocation to Vale (VALE3) because of valuation, while they have exposure to oil through Colombia’s Ecopetrol and have also added Brazil’s Petrobras (PETR4) as they assess that the political noise subsides. Seeing no near-term catalysts, BofA removed exposure to the pulp and paper sector, excluding Brazilian Klabin (KLBN11) and Chilean CMPC.

Among the Brazilian stocks in the portfolio of 12 Latin American stocks to gain from the reopening argument, the strategists have exposure in Bradesco (BBDC4), BR Distribuidora (BRDT3), Cosan (CSAN3), Hapvida (HAPV3), Itaú Unibanco (ITUB4), PagSeguro (this one traded on Nasdaq), TIM (TIMS3) and Vale (VALE3), totaling 8 Brazilian stocks in the portfolio.