Brazilian stocks have become one of Wall Street’s favorite destinations for investing this year as investors bet on big changes taking place in Latin America’s largest economy.
The Bovespa index, Brazil’s benchmark stock index, hit an all-time high on Monday and is up more than 8.5 percent thus far in 2019. The iShares MSCI Brazil ETF (EWZ), which tracks a basket of Brazilian stocks, has risen 12.2 percent this year. The EWZ is also outperforming EEM, the broader emerging-markets ETF, as well as funds tracking other emerging-market stocks.
The EWZ fund was up almost another 2 percent on Tuesday.
The jump in Brazilian shares comes as investors cheer the possibility of key reforms being passed by new President Jair Bolsonaro, including pension reform. However, Bolsonaro has a limited time period to make these changes. He is also a polarizing figure given racist and homophobic statements he has made in the past.
Bolsonaro is “hitting all the right notes the market has been wanting to hear for years,” said Chen Zhao, chief global strategist at Alpine Macro. “That’s why I think the market reaction has been so positive. If he really delivers on what he promised, I think that could turn out to be a major supply-side story in the EM world.”
Brazil’s new president was elected with overwhelming support. Bolsonaro won the presidency in October with 55 percent of the vote as Brazilians grew fed up with a spike in violence and lackluster economic recovery.
The Brazilian economy contracted all throughout 2016 on the heels of a massive price drop in oil, one of Brazil’s biggest exports. U.S. crude futures briefly traded around $26 per barrel in early 2016 before rebounding; they traded above $51 on Monday. The economy turned around in 2017, but only grew by 1.1 percent. Quarterly GDP growth did not reach 1 percent in the first three quarters, FactSet data show.
Jens Nordvig, founder of Exante Data, said Brazil’s economy should be growing much faster after its collapse in 2016.
“They just had the biggest recession literally in the history of economic statistics. Coming out of a recession like that, you should have like 4, 5, 6, 7 percent growth for a number of years and they just have not had that,” Nordvig said, adding this goes back to some of Brazil’s structural issues, including an overcrowded pension system.
Brazil’s current retirement age is 60 for men and 55 for women. This has led to massive debt in Brazil. As of the end of November, Brazil’s government debt level was more than 75 percent of GDP, according to data from the Brazilian central bank.
But Bolsonaro’s election has increased bets that Brazil would be able to reform the country’s crippling pension system. More than 91 percent of investors surveyed by Bank of America Merrill Lynch believe pension reform will be done in 2019, with one third of respondents expecting it to be approved in the first half of the year.
The newly minted president has already suggested hiking the retirement age to 62 for men and 57 for women. He has also issued a decree that rolls back some benefits.
Investors are also expecting Brazilian shares to build on their hot start to 2019. Sixty-eight percent of investors polled by Santander expect Brazil to be the top-performing country for Latin American equities.
Brazilian stocks are expected to get a boost from a slowdown in rate hikes from the U.S. Federal Reserve, which is also expected to boost broader emerging markets. They are also expected to benefit from a privatization and deregulation push by the Bolsonaro administration.
“Inflation expectations have moderated and the perception of a dovish Fed strengthens the case for [the Brazilian central bank] to stand pat,” strategists at MRB Partners wrote in a note earlier this month. “The new government’s bias in favor of privatization and smaller government will support a re-rating in a number of listed state-controlled enterprises.”
Investing in Brazil does come with its fare share of risks, however.
A formal proposal has not been presented yet and time is of the essence for Bolsonaro. The Bolsonaro administration has its best shot at implementing meaningful pension reform in the next six months, according to Elizabeth Johnson of TS Lombard. After that, it becomes more of an uphill battle.
“They have a debt profile that is unsustainable. They need to address that via pension reform and tax reform. Everybody knows that. It’s just a matter of what flavor those reforms take and how quickly they get through,” said Exante Data’s Nordvig. “If those reforms don’t get done, this administration has already failed. That’s just a must-have.”
Another risk is Bolsonaro himself. Bolsonaro is a polarizing figure in Brazil given past homophobic and racist comments. Bolsonaro told Playboy in 2011 he would rather have a dead son than a gay son. He also said in another interview that Haitian immigrants were bringing diseases to Brazil.
—CNBC’s Michael Bloom contributed to this report.