Strong headwinds in Brazil have recently blown its stock market off course. In the first quarter of 2015, Brazilian equities fell more than 15% in US dollar terms, as measured by the Bovespa Index. While current forecasts do not see these storms abating any time soon, our team finds reasons for optimism over the long term.
Expect more near-term pain
Brazil’s deteriorating macroeconomic situation is likely to persist this year, as it reflects a confluence of challenging factors, including:
- The weak macroeconomic policy of the past four years.
- A sharp decline in commodity prices, especially oil and iron ore.
- A massive corruption scandal at Petrobras, a global oil giant and one of Brazil’s largest companies.
- Water and potential power shortages in and around Sao Paulo, Brazil’s most populous city and its economic center.
- A slumping Brazilian real relative to the US dollar, which squeezes margins and makes it more expensive for companies to pay down dollar-denominated debt.
- High inflation, which forces the central bank to increase interest rates.
Given these conditions, the economy is likely to contract again in 2015. However, we believe policy changes are underway that could restore confidence, improving the outlook for 2016 and beyond.
Improvement may be on the horizon
Although the macro picture looks weak today, we see catalysts on the horizon that could help lift valuations over time — which is a key component of our earnings/quality/valuation (EQV) investment philosophy. The key reasons underpinning our optimism include:
- Structural reforms led by the new finance minister, Joaquim Levy. Levy is aiming for a primary fiscal surplus of 1.2% of gross domestic product (GDP) to help stave off a credit-rating downgrade. He is also looking to raise taxes and reduce government spending. Although austerity will be painful in the near term, we believe these are some of the necessary steps Brazil needs to take. It will take some time, but we believe Mr. Levy’s policies will get Brazil back on track.
- Improving sentiment. The worst may be behind us with Petrobras, which is set to report its audited results at the end of April (not a holding of Invesco International Growth Fund as of March 31, 2015). We also believe the currency has stabilized for the most part.
- Quality companies available at attractive prices. In our view, the market was oversold, which we considered a buying opportunity. For example, Banco Bradesco trades at a 1.7x price-to-book value with a return on equity of 20%.1 It has a price-earnings ratio of 9x and a dividend yield of 4%.1 We took the opportunity presented by the market’s recent weakness to add to this position. (1.57% of Invesco International Growth Fund as of March 31, 2015).
We continue to take a long-term approach to seeking value in Brazil. As we see it, the right seeds are being planted today for growth in the future.
1 Source: Bloomberg L.P. as of March 31, 2015
Learn more about Invesco International Growth Fund.
Important information
The Bovespa Index is composed of stocks that are traded on the Sao Paulo Stock, Mercantile & Futures Exchange, and is considered representative of Brazil’s equity market. An investment cannot be made directly in an index.
Price-to-book value is a common valuation metric for stocks which compares a stock’s share price to its book value per share.
Return on equity (ROE) is net income divided by net worth.
Price-earnings (P/E) ratio, also called multiple, is a common valuation metric for stocks that compares a stock’s share price to its per-share earnings.
Dividend yield is the ratio of a company’s dividend payout per year relative to its share price.
Holdings are subject to change and are not buy/sell recommendations.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The investment techniques and risk analysis used by the portfolio managers may not produce the desired results.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
All data provided by Invesco unless otherwise noted.
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Three Reasons Why We Like Brazil’s Prospects by Invesco Blog
