One week / one topic: Brazil

What happened?

Charles De Gaulle once quipped that “Brazil is the country of the future… and always will be”.

Local equities currently seem to agree with the latter part of the sentence, as they have meaningfully underperformed year-to-date and also look very cheap in both absolute and relative terms.

Looking at 2yr forward P/E ratios since 1990, valuations stand at the 7% percentile. Very cheap indeed.

If we zoom into the last 5 years and look at the most recent – and possibly more relevant – past, valuations are still only at the 18% percentile.

While real policy rates are indeed very restrictive – also when compared to other EM countries – perhaps this actually presents more of an opportunity for outperformance if (when?) rates come down and pressure is removed?

Our observations

• Fundamentals: Cheap valuations tend to skew probabilities in one’s favour, but we have been at similar levels for the last 2 years… It feels like more is needed here to prompt a meaningful repricing higher.

• Price action: Recent underperformance certainly stands out, yet the last few months have felt quite orderly and not particularly overdone. Also, no clear signs of a reversal.

• Investor beliefs: Investors seem mostly busy with other things, but positioning changes point to Brazilian equities gaining at least some attention as of late.

So what?

While we are observing Brazilian equities with increasingly piqued interest, it still seems premature to take a direct position as we don’t yet have the ‘all clear’ signal based on our investment framework.

In the meantime, we maintain our long-term allocation to Brazilian local currency bonds even after the scorching 2023 performance – where ~3yr notes returned 28% in USD terms.

While we further assess the prospects for Brazilian equities, one year Brazil government bonds still yield 10.4% – and indeed we have positions at the short end of the curve.

These yields represent an attractive reward to assume issuer and FX risk of the ‘country of the future’… for just the next 12 months.