A lot of good news is already priced into Brazilian equities
Having proved resilient during the second covid wave, the acceleration of the vaccination campaign should allow a steady reopening of the Brazilian economy. With the outlook improving, expectations for GDP growth this year have risen to above 5%. Encouraging data has been accompanied by inflationary pressures, prompting the central bank (BCB) to react swiftly and the market to price in an extra 200bps of rate hikes over the next three months.
While rising growth prospects and cheap valuations make the current optimism around Brazilian equities understandable, we believe most of the good news is already priced in and that the apparent cheapness of Brazilian equities reflects some justified concerns over the medium term. Part of the reason why Brazilian equities appear so cheap on an absolute basis is the meteoritic growth in expected earnings this year, of the order of 180%. But whereas earnings growth of this magnitude already looks to be priced in, earnings expectations for 2022 are much less rosy, with a contraction in earnings from the materials sector offsetting timid growth in other sectors.
Analysts’ expectations for earnings overall have been slowing in local-currency terms since the end of May. Our own internal earnings per share (EPS) model based on policy rates and the BRL exchange rate points to stable EPS expectations at best by the end of the year (in USD terms), assuming constant commodity prices. In other terms, we see limited upside potential for earnings upgrades during the rest of the year.
Unexcited by the outlook for Brazilian equities for the rest of this year, we are downgrading our position to neutral despite a slight rise in our year-end target for the Bovespa to 130,000.
The Brazilian real performed particularly well in Q2. It rose 13% against the US dollar and easily outperformed other EM currencies, thanks notably to an improving economic outlook and an increasingly hawkish central bank. However, we remain cautious about the real’s prospects over the longer term because of Brazil’s ongoing fiscal imbalances. Our projections for the USD/BRL rate are BRL5.10 in three months, BRL5.40 in six months.