Increased fiscal uncertainty, significant company devaluations, instances of government interference, and rising U.S. interest rates are contributing to a challenging stock market environment in Brazil
04/19/2024
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Thalles Franco — Foto: Silvia Costanti/Valor
Brazilian stocks have experienced steeper declines than those of other major emerging markets this year, signaling that domestic challenges play a substantial role in the underperformance of local equities.
According to a Valor Data survey using MSCI stock indices—which measure the performance of stock exchanges across various countries and regions—Brazil’s stock market has seen a decrease of 14.89% in 2024. In contrast, the average for emerging markets has only dropped by 0.5%, while the global average has actually increased by 3.5%. These comparisons are denominated in U.S. dollars, highlighting that the recent appreciation of the American currency against the Brazilian real has further exacerbated the poor performance of Brazil’s index.
Several domestic issues distinguish Brazil from its peers, including fiscal uncertainty following the adjustment of next year’s fiscal targets, struggles with key stocks such as Vale on the local exchange, and the volatility spurred by governmental attempts to meddle in the affairs of domestic companies.
On a global scale, the anticipation of a more restrained U.S. monetary policy has impacted equities worldwide. Brazil, where foreign capital had been more heavily invested prior to changes in the U.S. economic outlook, has felt the pinch acutely, suffering from a more pronounced outflow of funds.
According to J.P. Morgan, the significant underperformance of variable income in Brazil this year can be primarily attributed to a sharp decline in Vale shares, persistently high interest rates, and a substantial devaluation of the real.
The bank’s report highlights that Vale has been a major contributor to Ibovespa’s—Brazil’s benchmark stock index—losses in 2024. “If Vale’s performance had remained stable this year, Brazil’s performance in local currency would only be 1% behind MEXBOL,” notes the bulletin from J.P. Morgan’s equity strategy team for Brazil and Latin America, headed by Emy Shayo Cherman. MEXBOL refers to the Mexican stock exchange.
Vale’s common shares, which make up 14.16% of the Ibovespa and 10.99% of the Brazilian MSCI, have fallen by 15.65% this year. This decline is largely due to the global decrease in iron ore prices despite some recent signs of recovery. For most of 2024, however, the price of the commodity has been on a downward trend. Additionally, the Brazilian government’s attempt to appoint former Finance Minister Guido Mantega as the CEO of Vale has introduced further volatility, according to local fund managers.
“The price dynamics of iron ore until last week were quite poor, significantly impacting Vale. Several factors have negatively impacted the company, including discussions involving the CEO and instances of government interference,” explains Thalles Franco, partner and manager at RPS Capital. “With Vale being such a pivotal component of the index, the stock’s downturn largely mirrors the overall performance of Brazil’s market.”
Managers are particularly concerned with the fiscal challenges that have resurfaced following the government’s recent revision of next year’s fiscal target from a primary surplus of 0.5% of GDP to zero. “The fiscal dilemma has consistently been the weakest link in Brazil’s economic discussions. It surfaces repeatedly, manifesting with varying degrees of severity across different administrations. This recurring issue sets Brazil apart,” explains Eduardo Carlier, co-managing director at Azimut Brasil Wealth Management.
The adjusted fiscal target has recently prompted a rise in future interest rates, casting a shadow over the stock market. This increase places downward pressure on stocks linked to local consumption and heavily indebted companies while simultaneously boosting the appeal of fixed-income investments over variable-income investments in the country. “The balance still favors fixed income over riskier assets. Brazil needs to redirect local financial flows to make the stock market seem more enticing. However, periodic debates over fiscal policies hinder this; they obscure the market’s trajectory,” Mr. Carlier notes.
Additionally, there has been a notable retreat of foreign investors from the Brazilian stock market. Data from B3, the Brazilian stock exchange, reveals that this year, sales of shares by non-residents have outstripped purchases by R$27.39 billion. Meanwhile, global stock markets, including Brazil’s, are feeling the impact of shifting expectations for the U.S. Federal Reserve. Robust economic indicators from the United States are postponing any anticipated reductions in interest rates, posing challenges for global stocks. The exception has been the U.S. stock market, which continues to draw support from robust performances in the technology sector.
Welliam Wang, head of equities at AZ Quest, noted a shift in market expectations regarding disinflation in the United States. “Initially, the market anticipated a scenario where the U.S. could achieve disinflation without major sacrifices. Now, it appears we are moving toward a situation where, as the textbooks say, sacrifices are necessary,” Mr. Wang explained. Initially, Fed funds futures at the start of the year hinted at the beginning of monetary easing in March. However, current forecasts have adjusted this expectation to September.
Mr. Wang added, “With the U.S. entering an election period in September, the likelihood of interest rate cuts could further diminish, depending on the electoral frontrunner. The market perceives former President Donald Trump, who is seeking reelection, as potentially more inflationary due to his proposals to increase tariffs on China and restrict immigration, thereby reducing the labor force in the U.S.”
Thalles Franco, from RPS, highlighted how external movements have affected Brazil’s stock market. “Foreigners had significantly increased their investments in Brazilian stocks at the end of last year, drawn by attractive pricing. However, as U.S. interest rates began to divert investment flows away from emerging markets, Brazil, having seen substantial foreign investment, was particularly hard hit. The retraction of these funds around the turn of the year has been a major factor in Brazil’s underperformance,” he remarked.
In the final two months of 2023, non-residents injected a net R$38.49 billion into Brazilian stocks, accounting for the majority of the net R$44.85 billion that flowed into the country’s equity market throughout the entire year.
J.P. Morgan suggests that conservative expectations regarding the Federal Reserve’s actions may curb significant capital flows into the Brazilian stock market, even as U.S. interest rates begin to decline. The firm questions the impact of the Fed’s cautious stance: “Will a more restrained approach by the Fed be sufficient to support ‘high-beta trades’ [potentially higher returns] like those in Brazil? It might, eventually, but the potential gains from such a scenario are now less compelling than they were prior to the Fed’s temperance,” according to the report.
*Por Augusto Decker — São Paulo
Source: Valor Inernational