A Long, Lost Year Forecast for Brazil’s World-Lagging Stocks

(Bloomberg) -- For investors in Brazilian stocks, making even in 2020 may be a long shot.

With the Ibovespa index ending the first half down 18%, strategists see limited room for gains in coming months. On average, they predict the benchmark will finish the year at 100,000, a Bloomberg survey showed. While that represents a 5% advance from where it stood at the end of June, it’d be the smallest gain for any July-December period in five years. Moreover, it means the market would be still stuck with a loss for the year.

The rally that started in March and lifted the Ibovespa 50% is expected to lose some steam as Latin America’s largest economy, where the virus isn’t slowing down, faces a mounting challenge to balance its fiscal budget. While the central bank has cut interest rates to record lows and locals continued to flock to equities in search of better returns, foreigners remain wary.

With the Ibovespa down 37% in U.S. dollar terms this year, Brazil is the world’s second-worst performing market behind Colombia’s Colcap.

“On a scale of zero to 10, with 10 being most bullish, we’re six on Brazil right now,” Santander strategist Daniel Gewehr said in a phone interview. “There’s room for gains, but upside potential isn’t that big.”

One concern cited by Gewehr is the mismatch in the expected growth rate between corporate earnings and the economy. According to his calculations, Brazil’s gross domestic product is forecast to contract 1% annually over the next two years. By contrast, profits are estimated to grow at a pace of 4.9% over the period. “Something’s gotta give,” he said.

Trading 30 times 2020 earnings, the Ibovespa looks expensive. But when valued at 2021 earnings, stocks look much more reasonable with a multiple of 12. The index rose 1.2% to 96,203 in Sao Paulo Wednesday, with lenders Itau Unibanco Holding SA and Banco Bradesco SA leading gains.

For more: Strategists’ Ibovespa Index Estimates for Year-End 2020 (Table)

With Brazil posting the world’s second-biggest number of total Covid-19 infections, investors continue to monitor whether there might be any setbacks to the country’s gradual economic reopening.

“Uncertainty remains high and the market is still trading based on how the Covid-19 situation evolves,” said Emy Shayo, Latin America equity strategist at JPMorgan Chase & Co.

Consistent with global efforts to stem the economic fallout from the virus outbreak, Brazil’s central bank has lowered its key interest rate to 2.25% and said additional easing may be in store.

Lower yields have helped encourage local investors to favor stocks over fixed income. Their interest in equities grew in March even as the market suffered the worst month since 1998 and at one point trading was halted almost every day. In May, retail accounts registered with Brazil’s stock exchange B3 SA totaled about 2.5 million, up from 1.7 million at the end of last year.

In contrast, foreign demand has waned. To some, that’s good news because it means unspent buying power should sentiment start to shift. According to B3 data compiled by Bloomberg, offshore investors have pulled about 76.5 billion reais ($14 billion) from local stocks since the beginning of the year, excluding inflows through equity deals.

“Foreigners are certainly underweight on Brazil from a broad perspective and I would expect to see more foreign buying of Brazil stocks over the next few months,” said Caesar Maasry, a New York-based emerging-market strategist at Goldman Sachs.

For the equity advance to take hold in the market over the long term, economic reforms that have been derailed amid the health crisis need to regain traction, most strategists say. Last week, Brazil’s Senate approved the sanitation bill, which facilitates private investment in the sector. But other market-friendly measures -- including tax reform -- are considered unlikely in the second half.

“The debate is back to the table, but we still don’t have conviction that a series of reforms will take place this year,” said Bank of America’s Latin America equity strategist David Beker.

To fight the Covid-19 pandemic, Brazil has boosted public expenditures, worsening its fiscal outlook. The Economy Ministry estimates the country’s debt-to-GDP ratio will reach 93.5% by the end of the year. Uncontrolled fiscal deterioration is the top Brazil risk, according to a recent BofA survey of fund managers.

While the market outlook is less than stellar, investors may be better off picking the right stocks. Morgan Stanley strategists led by Guilherme Paiva recommended Banco BTG Pactual SA, which is ramping up its digital venture, and B3. JPMorgan advised investors to rotate from recent winners to stocks that haven’t done well or trade below book value, such as state-owned lender Banco do Brasil SA and food retailer Cia Brasileira de Distribuicao.

“In terms of fundamentals, there’s little room for more gains,” said Frederico Sampaio, the chief investment officer for equity at Franklin Templeton’s Brazil unit. “Of course you can’t fight against flows, but I believe the safety margin is gone.”

©2020 Bloomberg L.P.