Ibovespa had best month of the year in August; fixed-rate and inflation-linked bonds appreciated
09/01/2022
Jerome Powell almost spoiled the fun, but the Brazilian risk assets resisted the hawkish tone used by U.S. Federal Reserve chair at the end of the Jackson Hole meeting. While question marks remain as to where monetary tightening will go over there, there is already an end-of-cycle mood over here. Despite the uncertainties ahead, including about the general election in October and what the fiscal situation will look like from 2023 on, some people already see potential gains in classes traded at a discount.
In August, the Ibovespa rose 6.16%, to 109,523 points, after peaking at 113,813 points before the Jackson Hole event. IMA-B 5+, an index that reflects a basket of inflation-linked government bonds with terms over five years, gained 2.49%, rewarding those who lengthened their investment horizon. IRF-M, an index that represents fixed-rate bonds, appreciated by 2.05%.
In the stock market, foreign investors, who had slowed down their bets, put new money back into the spot market – almost R$18 billion in August, the highest in three months. The flow was still negative in the futures segment, at R$3.3 billion, but there was a net inflow of R$74.5 billion in the year, according to data provided by the exchange B3 and compiled by Leonardo Morales, the chief investment officer at SVN Gestão. “Despite the looming election, we saw a relevant capital flow from abroad, which propped up the Brazilian stock market and even detached it from the U.S. markets,” he said.
Fueled by foreign capital, August was the best month of the year for Brazil’s benchmark stock index Ibovespa, said Rodrigo Lopes, an equity strategist at Itaú Unibanco. “The Brazilian stock exchange has been trading for some time at a large discount to the historical average and to other emerging markets. Investors look at some multiples and see an attractive price.”
Although the indexes of international stock exchanges like Nasdaq and S&P500 are in the red this year, emerging markets like Brazil have underperformed them since 2019, Mr. Lopes said. In dollar terms, the MSCI Brazil benchmark is still far behind. As the earnings of companies listed in Brazil have increased in 2020 and 2021, he said the Ibovespa companies are trading at a discount of 40%, with the price-to-earnings ratio at 6.8 times, compared with a historical average of 10.8 times. This measure offers a glimpse of how long it takes to see a return on invested capital.
The domestic factor, he added, comes from the perception that the Central Bank is close to ending the monetary tightening cycle. If it hikes Brazil’s key interest rate Selic again in September, it is likely to be a residual adjustment in the rate currently at 13.75% per year. “As the stock market anticipates the cycles, it has started to price in sectors that do well in lower interest rate environments, such as consumption and construction stocks, which were very depressed at the beginning of the year.” There are risks, of course. If higher inflation data or a recession is confirmed in the United States, the Brazilian stock market is unlikely to remain unscathed.
In the balance of risks, Itaú’s investment strategy team is trying to weigh the chances of a recession in the U.S., what the Fed will do ahead, and the fiscal dilemmas in Brazil after the government change, to be defined in October. The scenario will rely on data, said Gina Bacelli, the chief economist of the team. The portfolio is more concentrated in fixed-income assets, with a neutral recommendation for the stock market.
Itaú’s tactic avoids dollar exposure but includes diversification into other currencies of 25% to 30% of the portfolio. “Until the [monetary] cycle is reversed, the real is unlikely to gain ground in a sustained manner,” said Mr. Bacelli, despite the fact that the Brazilian currency boasts one of the best performances this year. “International assets work as an anchor.”
Regardless of whether the Central Bank will raise the key interest rate again in September, the end of the cycle changes the view for fixed income, said Humberto Vingnatti Assis, Itaú’s strategist for the segment. “When the Selic remains flat, the market will begin to discuss at what moment the interest rate will be reduced again. This will be in the analyses in the coming months in the face of a very expressive [future] rate drop.”
With the movement in fixed-rate options, the decision was to reduce the exposure in these securities and put the gains in instruments linked to the interbank deposit rate (CDI). “We prefer to allocate risk where visibility is better,” Mr. Assis said. The National Treasury Notes series B (NTN-B, or Tesouro IPCA+) are also considered an attractive option.
As there is no clarity about a reversal of inflation in the United States and the Fed’s behavior, it was impossible to rely on the recovery of assets, such as the U.S. stock markets, before Jackson Hole, said Paulo Miguel, the chief investment officer at the Julius Baer Family Office.
The market bought the idea that the final rate of interest in the U.S. would be below 3.5%, he said. Mr. Powell’s speech on Friday threw cold water on this view by making it clear that there is some way to go before the economy’s rates match the target. “He emphatically signaled that inflation is the priority. Until we see convincing evidence, we can have a higher level of interest rates and the expectation of a cut next year seems premature,” Mr. Miguel said. “Fragility is there. It’s not going away any time soon.”
In this scenario, Brazil has nevertheless been a defensive position among emerging markets. One short-term trigger is the near end of monetary tightening, Mr. Miguel said. “This is the positive factor for the improvement seen in equities and the matters linked to the domestic economy.”
The second trigger driving prices of risk assets is expected to be defined in October, with the elections, and the indication of what the economic policy will be in the next administration.
Regardless of who wins the electoral race, Julius Baer believes that a pragmatic view will prevail and that none of the leading candidates will embark on a risky trajectory in the conduct of the budget. “The first year in office is typically the period of seeking to build confidence. It is what makes an expansionist posture ahead possible. We believe that this may happen again.”
After the Copom signaled the end of interest rate increases, the wealth-management firm adjusted investors’ portfolios. The portion concentrated in inflation-linked fixed-income assets was directed to equities.
Mr. Miguel sees the real still gaining ground amid the expectation of favorable commodity prices and a good agricultural harvest. Credit has been the preferred option abroad, with dollar-denominated bonds bringing returns of around 8% in up to four years.
With the upcoming electoral outcome and the possibility of some fiscal visibility starting in 2023, Credit Suisse is prepared to increase its exposure in the stock market or in fixed-income securities in Brazil, said Luciano Paiva, the bank’s chief investment officer in Brazil. “We see some volatility coming in the next weeks, but we are looking at the last two months of 2022 and the beginning of 2023 with a more upbeat view,” he said.
It will be a period in which the cycle of interest rate hikes in the United States will probably be clearer. The Swiss group believes that monetary tightening there will reach 4% or 4.5% a year, above what investors priced in future rates, but the rest of the adjustment could occur more mildly if inflation shows it has already peaked. “It would be good news for markets in general, the emerging markets, and for Brazil,” Mr. Paiva said.
In Brazil, the assessment is that the Central Bank has moved early to raise interest rates and will soon end its work. Since the second quarter, the monetary authority has shown signs that it would like to halt the increases in the Selic rate, but it was surprised by inflation, and “whether it likes it or not, monetary tightening abroad adds some pressure.”
When one looks at fixed-rate bonds in Brazil, with rates above 12%, or even for inflation-indexed bonds, close to 6%, there seems to be a premium in relation to what would be the natural rate of interest, around 4% or 4.5%, Mr. Paiva said.
Credit Suisse prefers assets linked to real interest rates, but has occasionally bet on fixed-rate securities. It has a small portion on it, of 2.5%, but the discussion is whether it is worth increasing it. The bank is neutral on the stock market in Brazil as well, because falling long interest rates benefit risk assets such as stocks. “We will discuss which is the best horse when the election is defined.”
*By Adriana Cotias — São Paulo
Source: Valor International