Brazil: Angst or opportunity? - LATIN AMERICA PULSE - JP Morgan Asset Management
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J.P. MORGAN PRIVATE BANK
LATIN AMERICA PULSE
Brazil: Angst or opportunity?
What impact might the country’s political uncertainty have on its rebounding economy?
April 2018
J.P. Morgan Private Bank recently visited São Paulo, Curitiba, and Rio de Janeiro, Brazil, to present our global macro and markets
views. Local investors also shared their insights on the current state of affairs and economic outlook for the country. Below is a
summary of the key views we presented to investors and of the local color they shared with us.
BRAZIL POWERS ON
Many local investors see Brazil powering through rising global
IN BRIEF
interest rates and protectionism fears to deliver stronger growth in
the foreseeable future. They are encouraged by Brazil’s emergence • Many local investors see Brazil delivering stronger
from recession, which is supported by key structural reforms and growth in the foreseeable future
the adoption of a more market-friendly policy framework. While • We believe political uncertainty is in fact highly likely
this positive sentiment is driven by the assumption that the to prevail in the months ahead, potentially giving rise
October presidential election will produce a relatively benign to reform implementation risks and the possibility of
outcome, with a centrist candidate ultimately winning the race, reoriented policy agendas
some observers warn that it may be a bit premature to call the
election and to conclude that the current pro-business policy thrust • Real GDP is projected to expand by 3.0% in 2018 and
will be maintained. a further 2.5% in 2019
• Despite the steady progress, the reform agenda is
still incomplete, and current policies are not assured
Many local investors believe Brazil can amid political and policy uncertainty
deliver stronger growth in the • Social security reform remains a priority in Brazil.
At present, the pension system is a sizable burden
foreseeable future by any measure
• External balances have improved over the past few
After Brazilian courts ruled that, as a convict, former President years. The CAD is projected to widen to 1.4% of GDP
Luiz Inácio Lula da Silva (known throughout Brazil as Lula) would in 2018 and to 1.7% in 2019
have to appeal his 12-year corruption sentence while serving time
in prison, it greatly diminished his chances of standing for election.
The Worker’s Party (Partido dos Trabalhadores, or PT) still claims negative impact on the economy in the near term. Clarity may not
Lula as its candidate, and his supporters have been mounting an be forthcoming until August, when presidential candidates have to
aggressive campaign to sway the courts. be officially registered. At that point, the top electoral court would
be required to make a final determination on Lula’s candidacy.
Despite his imprisonment, Lula could still register for this year’s
presidential race, though most pundits believe there is a high In the meantime, many investors, particularly local ones, continue
likelihood that the top electoral court would bar his candidacy. to believe Lula will not be legally allowed to run for the presidency
Complicating matters, the first poll released after his jailing and the outcome of the election will be fairly benign (at least from
showed that Lula is still the front-runner, and by a wide margin. a market standpoint). Hence, investors are seemingly comfortable
Moreover, no centrist candidate—who would be the clear choice of remaining actively invested in Brazilian assets. This is a chance that
most investors—is showing much traction at this point. Populist more cautious investors are reluctant to take. Many investors view
candidates from both the right and the left of the political the outcome of the election as strictly binary, and hence
spectrum are enjoying most of the positive momentum. dangerously unpredictable.
The bottom line is that uncertainty remains the name of the game We believe political uncertainty is in fact highly likely to prevail in
in Brazilian politics. It is something that could conceivably have a the months ahead, potentially giving rise to reform implementation
INVESTMENT PRODUCTS: • NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE
Please read Important Information at the end of the presentation.LATIN AMERICA PULSE: BRAZIL | 2
risks and the possibility of reoriented policy agendas, something Real GDP growth
that could, in turn, generate both anxiety and opportunity among % change y/y
investors. 4.0%
3.0 3.0
3.0 2.5
Growth recovers materially, inflation dips meaningfully
2.0
Following a very deep recession in 2015–2016—the economy
1.0
contracted nearly 8% as commodity prices collapsed—Brazil’s real 1.0 0.5
GDP began growing again in 2017, inching up 1.0%. Real GDP is 0.0
projected to expand by an above-trend and above-potential 3.0% -1.0
in 2018, and by a further 2.5% in 2019, boosted by stronger -2.0
private consumption and investment, as well as a meaningful
-3.0
recovery in commodity prices. Beginning in 2020, the IMF expects
-4.0 -3.5 -3.5
medium-term growth in Brazil to moderate to around 2.2%, much
2013 2014 2015 2016 2017E 2018F 2019F
closer to its 2.0% potential.
Sources: IBGE, BCB, J.P. Morgan. Data as of April 2018.
Real GDP is projected to expand in Social security reform and fiscal consolidation remain
key challenges
2018 and 2019 The economic policy framework drastically changed in 2016,
following years of decline that drove the fiscal deficit to a
considerable 10.2% of GDP in 2015. Much has been accomplished
Headline inflation in Brazil—which fell to 2.9% in 2017, its lowest since: The government introduced a cap on public spending, laws
level in 20 years—is likely to remain subdued and print in the were approved to help improve governance in state-owned
3%–4% range in 2018. This is supported by a gradual close in the companies, and labor reform that was intended to lower litigation
output gap, a stable exchange rate and well-anchored inflation costs and enhance labor market flexibility has been implemented.
expectations, supported by improvements to the country’s The fiscal deficit benefited from these measures, narrowing to 9.0%
monetary policy framework. Inflation is expected to increase of GDP in 2016 and to 7.8% in 2017. It is projected to dip further to
slightly in the medium term. However, it should remain at levels 7.6% and 7.4% of GDP in 2018 and 2019, respectively. Despite the
well below the average for the past decade, albeit bolstered by steady progress, the reform agenda is still incomplete, and the
firmer core inflation and a modest pickup in commodity prices. continuity of market-friendly and fiscally disciplined policies is by no
All in all, many local investors agree that Brazil’s current macro means assured amid political and policy uncertainty.
picture is quite strong. With growth trending higher, inflation Social security reform remains a priority in Brazil. It will help to
contained, structurally low interest rates in place, a manageable guarantee that government spending is consistent with the
current account deficit (CAD) and strong foreign direct investment constitutional fiscal rule and to ensure long-term fiscal
(FDI)—adding that if the outcome of the upcoming election is sustainability. While local pundits believe pension reform will indeed
positive from a market standpoint—the stars could finally align be approved—although not until 2019—they also believe that under
for Brazil. a new administration, it will be a necessary, albeit insufficient,
condition to comply with the spending cap in the medium term.
Accordingly, additional fiscal measures aimed at reducing other
mandatory spending may be necessary. At present, Brazil’s pension
Headline inflation in Brazil is likely to system accounts for roughly 55% of government spending, a sizable
remain subdued in 2018 burden by any measure. As such, it is widely recognized that
pension reform is not only necessary to narrow Brazil’s fiscal deficit,
but also essential to improve its deteriorating debt dynamics.LATIN AMERICA PULSE: BRAZIL | 3
Fiscal deficit
% GDP J.P. MORGAN PRIVATE BANK EXPECTATIONS
12.0% FOR BRAZIL:
10.2 • Real GDP to expand by an above-trend and above-potential
10.0
9.0 3.0% in 2018, boosted by stronger private consumption and
7.8 7.6 investment. Following a very deep recession in 2015–2016,
8.0 7.4
6.0 real GDP returned to growth in 2017, inching up 1.0%
6.0
• Headline inflation to likely remain subdued and print in the
4.0
3.0 3%–4% range in 2018, after falling to 2.9% in 2017, its
lowest level in 20 years
2.0
• Fiscal deficit to dip to 7.6% of GDP, after narrowing to 9.0%
0.0
2013 2014 2015 2016 2017E 2018F 2019F
of GDP in 2016 and to 7.8% in 2017, benefiting from a
number of reforms; a major overhaul of the pension system
Sources: BCB, J.P. Morgan. Data as of April 2018.
is viewed as critical to restore fiscal order
• External balances to widen to a still manageable 1.4% of
External accounts solid; external buffers ample GDP in 2018, given the acceleration in economic growth.
External balances have improved significantly over the past few Balances improved significantly over the past few years;
years. Trade surplus climbed to unprecedented levels in 2017 on the current account deficit (CAD) shrank to 0.5% of GDP in
export expansion that is much stronger than import expansion, 2017 from a peak of 4.2% in 2014
prompting the current account deficit (CAD) to shrink to only 0.5%
of GDP in 2017 from a recent peak of 4.2% in 2014. The CAD is MACRO VIEW: SYNCHRONIZED GLOBAL GROWTH
projected to widen to 1.4% of GDP in 2018, due to accelerated BROADENS AND STRENGTHENS
economic growth, and to 1.7% in 2019. It is expected to remain at
very manageable levels, allowing Brazil to continue to strengthen We believe the current global cycle is the most synchronized in at
its already large buffers against external shocks, with international least a decade, as fundamentals in Europe, Japan and emerging
reserves hovering around a pretty healthy 18% of GDP. markets continue to improve, relieving the United States of the
pressure of being the sole driver of economic expansion. As the
While the United States and China are important markets for world economy continues to fire on multiple cylinders and growth to
Brazilian exports, local investors do not seem overly concerned accelerate, the global backdrop and prospects are far more favorable
about the impact of mounting protectionism on the domestic today than only a few years ago, contributing to an ideal investment
economy, which is expected to continue to benefit from rising environment.
commodity prices. Meanwhile, foreign direct investment inflows
have been quite strong and remain fairly well diversified, in terms A surge in international trade volumes, a meaningful uptick in
of economic sector and region/country of origin. These inflows are corporate profits, and improving business sentiment support the
contributing to the overall strength of Brazil’s external accounts idea that global capex could boost global growth to around 3.8% in
and hence its overall economic might.
2018, materially above potential. Moreover, European corporate
earnings, which are still early in their recovery process, could help
Current account deficit
% GDP provide a longer runway for fundamental support in the near term.
5.0%
Meanwhile, Japanese corporate performance has seemingly
4.2
decoupled from the yen, as earnings have risen despite currency
4.0 strength. Labor market dynamics in Europe and Japan have
3.3 improved markedly, and unemployment has fallen to levels not seen
3.0
3.0 in several decades, helping to fuel global demand. Commodity-
induced imbalances in emerging markets have generally corrected,
2.0 1.7 while weaker currencies have enhanced trade competitiveness.
1.3 1.4
Despite the deepening of the current global expansionary cycle, the
1.0
0.5 risk of overheating seems quite limited. While broader and stronger
global macroeconomic expansion and an uptick in commodity prices
0.0
2013 2014 2015 2016 2017E 2018F 2019F should boost Brazil’s growth momentum, political and fiscal
uncertainty could continue to cloud its near-term outlook.
Sources: BCB, J.P. Morgan. Data as of April 2018.LATIN AMERICA PULSE: BRAZIL | 4
MARKET OUTLOOK: POLICY GRADUALISM Global asset prices garner support
IS THE NAME OF THE GAME Although equity and fixed income valuations may not be cheap, low
inflation, low interest rates and the low cost of cash should continue
Historically low unemployment rates, relatively easy financial to support global financial asset prices, in particular risk assets. We
conditions and modest inflation prints should enable the Federal envision double-digit gains for equity markets in the United States
Reserve to hike the policy rate three more times (25 bps each) in (bolstered by corporate tax reform and capital repatriation), Europe
2018. This, coupled with fiscal easing, should help push the 10-year (where companies are still early in their recovery process), Japan
Treasury yield a tad higher, to 3.10% (+/-25bp) by year-end. We (where local equities still trade at a discount to global equities) and
expect the European Central Bank to terminate its bond-buying Asia ex-Japan (where equities stand to benefit from stronger global
program in late 2018, but we do not foresee any rate hikes demand).
until 2019.
In the fixed income arena, we expect the front end of the U.S. yield
By contrast, Japan’s extraordinarily accommodative policy stance is curve to rise more than the back end. This is normal during the latter
likely to remain in place for a few more years, as the Bank of Japan stages of an economic cycle, and hence not a great source of
continues to battle against persistent deflationary pressures. At the concern. Strong global growth and relatively cheap valuations favor
same time, while higher domestic interest rates may stabilize the emerging markets (particularly local), rather than developed market
U.S. dollar in the near term, the greenback may lose some of its debt. That said, investors must be mindful of idiosyncratic risks and
luster toward year-end, as other regions start to catch up to U.S. be selective when making allocations to the emerging markets
tightening endeavors. In fact, limited impact from further monetary universe. Overall, we expect 2018 to be another year of cash
policy normalization and rich valuations could significantly constrain underperformance. Despite elevated levels of political and fiscal
the U.S. dollar, making emerging market currencies more compelling. uncertainty, we believe a very favorable global economic backdrop
and a positive market bias have continued to underpin Brazil’s
investment appeal.
FRANCO UCCELLI is Head of Client Investment Strategy for Latin America at J.P. Morgan Private Bank. His responsibilities
include formulating and communicating to clients a cohesive and comprehensive vision of the Private Bank’s investment
strategies, as well as its macroeconomic and market views.
Mr. Uccelli was previously a member of the Emerging Markets Research team at J.P. Morgan’s Corporate & Investment
Bank, with primary coverage responsibility for Chile, Peru, Paraguay, Uruguay, Central America and the Caribbean, and
the Bear Stearns Emerging Markets Sovereign Research group. Mr. Uccelli’s financial services career began in Miami,
where he worked for various international commercial banks and held positions in international credit. His responsibilities
were focused on providing country risk analysis for the Latin American and Caribbean regions, as well as recommending
and monitoring country exposure levels.
Mr. Uccelli holds a bachelor’s degree in Economics and Latin American Studies from Brandeis University, as well as a
master’s degree in Latin American Economics from Vanderbilt University and a master’s degree in Comparative Politics
from the University of Texas at Austin. He has also completed coursework for a Ph.D. in International Studies from the
University of Miami.
He has been ranked by Institutional Investor as one of the top sell-side analysts for Chile and has been winner of
FocusEconomics Best Economic Forecaster Awards for Costa Rica and the Dominican Republic.LATIN AMERICA PULSE: BRAZIL | 5 IMPORTANT INFORMATION Please be aware that any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are, unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all-inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. JPMorgan Asset Management Marketing Limited accepts no legal responsibility or liability for any matter or opinion expressed in this material. The value of investments and the income from them can fall as well as rise and investors may not get back the full amount invested. Past performance is not a guide to the future. Purpose of This Material This material is for information purposes only. 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