Morgan Stanley cuts Brazil shares amid Lula da Silva’s spending plan

Morgan Stanley is pulling away from Brazil’s stock market as there is a risk that President-elect Luiz Inácio Lula da Silva’s appetite for more spending will derail expectations of interest rate cuts next year.

The bank downgraded Brazilian stocks from overweight to neutral in its Latin American portfolio after strategists led by Guilherme Paiva highlighted the risk of Lula da Silva appointing an unorthodox finance minister and the Selic rate staying higher for longer, under a scenario of relaxed fiscal policy.

If that materializes, “the next few years should be good for Brazil’s fixed-income assets, but not for equities,” Paiva writes. “Higher real bond yields should undermine the seemingly attractive valuation story for stocks.”

Brazilian stocks are trading at 6.8 times forward earnings, well below their 10-year historical average of 11.4 times, amid concerns that Lula da Silva will pursue fiscally wasteful policies in Latin America’s largest economy.

While local markets held up well for most of the election period, they have underperformed their peers since the leftist leader was elected last month.

The Ibovespa index is likely to end 2023 at around 125,000 points, suggesting there is room for a 15% rise from Friday’s close, according to the bank.

Last week, at a Bloomberg event, the president of Brazil’s central bank, Roberto Campos Neto, said that it is too early to celebrate a victory in the fight against inflation and that monetary policymakers will react if the growth of the prices prices are not slowing towards the target.

Morgan Stanley also took the opportunity to upgrade Mexico’s rating to an overweight thanks to its links to the US economy, which is expected to avert a recession in 2023.

The Mexbol index will likely end next year at 70,000, up 36% compared to Friday, as the country could benefit from companies moving their production closer to customers, known as nearshoring, the bank says.

Companies featured on Morgan Stanley’s list of top Latin American stock ideas include MercadoLibre Inc., Itaú Unibanco Holding SA, Porto Seguro SA, Sendas Distribuidora SA, Weg SA, Vale SA, Americanas SA, Fibra Prologis, Grupo Aeroportuario del Centro Norte SAB (OMA) and Credicorp Ltd.

With information from Bloomberg Línea