Brazil Election 2018: Markets Rally after First Round Results
Bullish market reaction as Bolsonaro leads in the first round of the Brazil’s presidential election.
October 15, 2018
scroll to view the report
After the first round of voting in Brazil’s presidential election, far-right candidate Jair Bolsonaro has taken a stronger-than-expected lead over the leftist Workers’ Party candidate Fernando Haddad. Brazilian markets welcomed the result, adding to the gains already seen in the last month, when Bolsonaro’s lead in the polls started to increase. The J.P. Morgan Research team takes a look at what the election could mean for the Brazilian economy and markets in the run up to and aftermath of the historic decision.
What’s the Outlook for Brazil’s Economy?
The vote comes as Latin America’s biggest economy is still struggling to return to strong growth after climbing out of a two-year recession in 2017, its worst downturn on record. Throughout this year, J.P. Morgan’s view on the Brazilian economy has changed a great deal. “At the beginning of 2018, we started the year bullish, expecting GDP to expand 2.8%, with inflation well below the target. Since then, we have trimmed our growth forecasts significantly,” said Cassiana Fernandez, J.P. Morgan’s Chief Economist for Brazil, who now sees Brazil growing 1.2% in 2018 and 2.3% in 2019. This change of view was due to several factors:
Firstly, there has been a crisis in several Emerging Market (EM) economies, most notably in Turkey and Argentina. The Turkish lira hit a record low against the U.S. dollar (USD) amid trade tensions with the U.S. In Argentina, a weaker currency led to higher inflation and the government was granted a bailout package from the International Monetary Fund. At the same time, global GDP forecasts have also decreased. On top of these external factors, a major nationwide trucker strike took place in May. The strike paralyzed the country for 10 days with road blockades and food shortages, further impacting economic activity and heightening political concerns. The public support for the strike also revealed how dissatisfied Brazilians are with the current economic environment and their general lack of confidence in government.
Brazil Real GDP growth and inflation
Real GDP growth
Source: J.P. Morgan, *simple average
This rise in social tension has added to the uncertainty surrounding the election and J.P. Morgan analysts now estimate there is just a 50% chance the next government will promptly be able to address the key fiscal challenges the country faces. These factors have hit Brazil’s currency, the real (BRL), which has tumbled by as much as 20% against the USD year-to-date (YTD), but has recently regained some ground as Bolsonaro has shown a consistent lead in polls. Following the news of Bolsonaro’s victory in the first round of voting, the real gained over 2% against the dollar.
“Markets have been more favorable to Bolsonaro’s liberal agenda and I think the central bank will be comfortable holding rates until the end of the year, or even the beginning of next year. We expect rates to remain stable at 6.5% going to 2019 and then normalizing up to 8.25% next year. Whoever is elected will need to show willingness and an ability to address Brazil’s fiscal challenges. One of the main issues will be to approve a significant social security reform and to convince the market the country can go through a more stable public debt path,” Fernandez said.
What Does the Election Mean for Markets?
After the first round, the presidential race will still need to proceed to a second round as neither candidate secured a 50% majority. However, with 46% of the valid votes Bolsonaro surprised to the upside relative to pre-election polls and has taken an almost 17 percentage point lead over Haddad. The result was welcomed by markets, with Brazilian assets rising on the news as Bolsonaro promises a liberal economic agenda. While there is some uncertainty regarding the new government’s ability to push through a reform agenda, J.P. Morgan’s outlook for financial markets in the region remains positive. In July, the global asset allocation team upgraded EM equities to overweight and within this, Brazil is an overweight in both the EM and the Latin America portfolios. There were a few factors that led to this overweight positioning for EM equities, according to Head of Equity Strategy for Latin America (LatAm) and Brazil, Emy Shayo. “The two most important are first, very light positioning as we saw a lot of assets leaving EM during the first half of the year and second, very large underperformance when compared to developed market equities,” Shayo said.
“Once we have an end to the uncertainty caused by global factors and the election, Brazilian companies will have a new beginning to go with a reacceleration of the economy next year, even if it’s not a spectacular one.”
HEAD OF EQUITY STRATEGY FOR LATAM AND BRAZIL, J.P. MORGAN
Lingering trade tensions between the U.S. and China, a stronger USD, the crises in other EM regions and the election have all weighed on the Brazilian market, with equities under pressure for much of the year. Brazilian stocks posted strong gains after Bolsonaro’s first-round win and J.P. Morgan Research now suggests Brazil valuations have re-rating potential, with state-owned companies and rate-sensitive stocks set to benefit most. J.P. Morgan’s overweight positioning for Brazil equities is also based on the outlook for Brazilian companies. “These companies have survived a recessionary environment, competition today is a lot lower, they have cut costs, they have deleveraged and today they are full of cash and idle capacity. Our view is that we are entering a very positive earnings cycle for Brazilian companies and results are starting to show this,” Shayo said, noting that GDP is also expected to accelerate in 2019 from current levels. “Brazil has already gained about 15% in dollar terms in the last 30 days. It is the best performing EM market at a moment when EM is actually de-rating,” Shayo added.
Nevertheless, this election still carries uncertainty for markets. The internet is being used to heavily influence voters and there is real polarization and fragmentation between candidates and proposals. ”There is also a real sense of urgency from markets regarding the fiscal situation. The last time we had an election, the fiscal situation was about 50% better than it is right now. The deficit has continued to increase and Brazilian debt has become the largest in EM,” Shayo added.
Brazil’s high debt levels remain a challenge
Gross debt to GDP*
Source: IMF, April 2018 WEO database
A Battle of Extremes
No fewer than 13 candidates registered as presidential contenders, with just two proceeding to a second round poll taking place at the end of the month. The two leading candidates that made it through the first round are from opposite ends of the political spectrum and have both outlined a starkly different vision for Brazil’s economy. On the far-right is front-runner Jair Bolsonaro. The retired army captain emerged from a violent assault in September stronger-than expected, capturing 46% of the vote in the first round. On the other side is leftist Workers Party (PT) candidate, Fernando Haddad. Haddad is standing in place of PT’s jailed founder and one of Brazil’s most popular politicians, former President Luiz Inacio Lula da Silva, known as “Lula”, who was barred from running due to a corruption conviction
“We have a large number of people who say they are not voting for anyone. In 2014, polling agencies showed about 25% of the population decided who they were going to vote for in the last week”
HEAD OF EQUITY STRATEGY FOR LATAM AND BRAZIL, J.P. MORGAN
Low trust in Brazilian institutions
% of responses stating total or partial trust, August 2017
Source: Ibope. Updated Aug 09, 2018
Haddad trailed Bolsonaro with 29.3% of the vote, meaning both candidates will face each other again in the second round on October 28th, with Bolsonaro’s chances of securing victory looking likely. “It’s important to note that we have never seen a turnaround in the second round. Those that go first in the first round are elected. We also saw a very strong anti-PT sentiment and this election has now narrowed down to a very simple question – do you want the PT back in power or not? We saw the PT losing major ground in the Senate and there is real fragmentation in Congress,” Shayo said.
If he wins, Bolsonaro’s administration would likely have enough support to gather a simple majority in government, particularly since his coalition performed well in the congressional elections. However, for constitutional amendments such as social security reforms, the outlook is still challenging with 60% of votes required. Leftist parties, who will likely reject reforms, elected 150 deputies (30% of the House) and 13 senators (16%), meaning Bolsonaro would need to rely heavily on votes from centrist parties to push through any meaningful reforms. While his lead looks relatively secure, voters in Brazil are generally very skeptical of political parties and a large number have said they will abstain from voting altogether.
Brazil election calendar 2018
Band TV debate
Electoral advertisement starts
(including TV and radio electoral program)
TV Gazeta/Estadão debate
Rede TV debate
SBT TV debate
Record TV debate
Globo TV (last one before the election)
Electoral advertisement ends
(including TV and radio electoral program)
Learn more about J.P. Morgan’s Latin American regional offering combining the people, tools, products and capital to connect you to opportunities around the world for over 150 years.Read more about Your local partner in Latin America
Here’s a roundup of the highlights from the event.Read more about Emerging Markets in the Spotlight
Do U.S. tariffs pose a risk to global growth?Read more about The New World Trade Order
This communication is provided for information purposes only. Please read J.P. Morgan research reports related to its contents for more information, including important disclosures. JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively, J.P. Morgan) normally make a market and trade as principal in securities, other financial products and other asset classes that may be discussed in this communication.
This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy except with respect to any disclosures relative to J.P. Morgan and/or its affiliates and an analyst's involvement with any company (or security, other financial product or other asset class) that may be the subject of this communication. Any opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This communication is not intended as an offer or solicitation for the purchase or sale of any financial instrument. J.P. Morgan Research does not provide individually tailored investment advice. Any opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. You must make your own independent decisions regarding any securities, financial instruments or strategies mentioned or related to the information herein. Periodic updates may be provided on companies, issuers or industries based on specific developments or announcements, market conditions or any other publicly available information. However, J.P. Morgan may be restricted from updating information contained in this communication for regulatory or other reasons. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.
This communication may not be redistributed or retransmitted, in whole or in part, or in any form or manner, without the express written consent of J.P. Morgan. Any unauthorized use or disclosure is prohibited. Receipt and review of this information constitutes your agreement not to redistribute or retransmit the contents and information contained in this communication without first obtaining express permission from an authorized officer of J.P. Morgan.