Post-Election Views on Brazil ETFs

Pro-markets populist Jair Bolsonaro decidedly won Brazil's presidential election, potentially signaling a new era for Latin America's largest economy and its financial markets. Bolsonaro, dubbed a right-leaning, anti-establishment candidate by some market observers, was the market's preferred choice.

For the 90 days ending Oct. 30 – a period including a time in which Bolsonaro ascended in the polls, commanded the largest percentage in the election's first round and ultimately won the presidency – the iShares MSCI Brazil ETF (EWZ) and the VanEck Vectors Brazil Small-Cap ETF (BRF) rose 12.20% and 6.80%, respectively. The MSCI Emerging Markets Index plunged nearly 13% over the same period. EWZ is the largest Brazil exchange-traded fund (ETF) listed in the U.S.

"Yet we see the decisive victory by Bolsonaro – widely perceived as more market friendly than his left-wing opponent Fernando Haddad – as largely priced in by financial markets," said BlackRock in a recent note. "Further gains in Brazilian assets will hinge on the new government's success in pressing ahead with economic reforms, particularly of Brazil's bloated pension system, in our view."

Bolsonaro's efforts to bring his reformist agenda to life are crucial to the near- to medium-term fate of Brazilian stocks, which are among the most volatile among large emerging markets. The large-cap EWZ and the small-cap BRF have three-year standard deviations of 33.33% and 30.66%, respectively, well above the comparable metric on the MSCI Emerging Markets Index.

"These reforms – which include spending curbs, privatizations and a loosening of labor market laws – have helped support a gradual economic recovery," said BlackRock. "Yet if Bolsonaro were to act in ways that damaged institutions, as some fear, this could pose longer-term risks to Brazil's growth."

For 13 of the past 15 years, Brazil's presidents have been left-leaning, underscoring some of the concerns around Bolsonaro's provocative economic and social views. Since the start of 2003, EWZ has easily outpaced the MSCI Emerging Markets Index, but in recent years, rising corruption, inflation and profligate spending have weighed on Brazilian assets. From 2012 through 2017, EWZ generated positive annual returns just three times and outperformed the MSCI Emerging Markets Index just once (in 2016).

Bolsonaro's Social Liberal Party won an unexpected number of seats in Brazil's lower congressional house, which could help the newly elected president push through his agenda, including pension reform.

"A growing debt burden, driven by massive social security obligations, is Brazil's key challenge. We see broad support for reforming social security," according to BlackRock. "The president of Brazil's lower chamber has said he would bring a pension reform bill up for a vote if the new president-elect publicly supported it. A key focus for investors will be the net present value of fiscal savings from any future cuts to benefits."

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