It seems like the bad news keeps piling on for Brazil. The economy is in the middle of a prolonged recession (GDP is down about 5% year over year) and unemployment and inflation remain high (both around 8%). Political scandals have culminated in an impeachment trial of President Dilma Rousseff, which begins this week. On top of all that, the country has been trying to deal with public health issues relating to the spread of the Zika virus. While the Olympics certainly brought attention to the country, these types of events tend to ultimately be an economic drag instead of a boon for the host city. Los Angeles is still the only city to record a profit after hosting the Olympics in 1984. However, there is a bright spot in Brazil: it has one of the best performing stock markets year to date.
The MSCI Brazil Index is up 33% year to date in local currency. The Brazilian Real has also strengthened vs. the U.S. Dollar, so this translates into a gain of 63% for U.S. investors and makes it the best performing country in USD terms. So what’s been driving the return? There are multiple factors at play, but my hunch is the rebound in oil prices is primarily driving the rally. The price of Brent crude oil is up 32% year to date. Add a percentage point for the “Olympic Host Country Bounce” and renewed confidence in the political system and that’s close to the local return mentioned earlier. The index hasn’t moved in lockstep with oil prices, but energy accounts for about 13% of the country’s GDP (as a reference, oil and gas contribute about 22% to Alaska’s GDP and about 1.8% to the United States’ GDP). So when oil does well, so does Brazil.
Valuation-wise the recent returns make sense, Brazil’s stock market was considered “cheap” when the rally started. The forward P/E ratio for Brazil’s stock market reached a 5 year low of about 7.5 right before the turnaround (the 5 year average forward P/E is about 10). This highlights the fact that value investing is hard because valuations are almost always most attractive when headlines are the worst. Check out this story published in The Economist in January about two weeks before the rally began, “Brazil’s fall: Disaster looms for Latin America’s biggest economy.” Brazil’s market is now trading at a forward P/E ratio of about 12.5, and you’ll never guess what story The Economist published last week on Brazil.
The rally in the Brazilian stock market is positive for client’s portfolios as all of our models have an allocation to emerging market equities. We use the MSCI Emerging Markets Index as a benchmark for this exposure. Brazil is the third largest country in this index, making up approximately 6.5% of the constituents. However, on a portfolio level, the returns from a single emerging market country are incremental as the asset class is well diversified and consists of several thousand companies that are spread across 23 countries. While Brazil is a very small part of APCM’s portfolios, as a whole, clients have been able to benefit from Brazil’s exceptional returns this year.