Brazilian Presidential Election: The next Event on our Radar - By Daniela Savoia, EM Credit Analyst 08/15/2018 - Fisch Asset Management
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Brazilian Presidential
Election: The next
Event on our Radar
By Daniela Savoia, EM Credit Analyst
08/15/2018Fisch Asset Management Brazilian Presidential Election | 08/15/2018 Page 2 | 6
Brazilian Presidential Election: The next Event on
our Radar
— October Brazilian Election is the next key event to watch
— Our view on different possible outcomes: the good, the bad and the jailed ex-president
— Possible impact on quasi-sovereigns, financials and private corporates
The market is rightfully focused on Argentina, Turkey and Russia at the moment, and so are
we. However, there is another key event brewing in the background, and we see the next
focus of investors to become Brazil with the October Presidential Election coming up.
The biggest question for Brazil this year is who will become the next president. This is not just
any election for the country; it is the first one since the impeachment of the last elected pres-
ident and the first one since Brazil entered a recession. The country is just overcoming a re-
cession and government debt is on the rise (see Figure 1). Given this context, the next presi-
dent will have an enormous influence on the success, or failure, of the country’s recovery. At
Fisch, we are closely monitoring the situation given its importance within emerging markets,
especially as Brazil accounts for 6.2% of the J.P. Morgan CEMBI Index, the largest weight of
any country other than China.
Figure 1: Government Debt and GDP Growth Evolution
Gross Govt Debt (% GDP) Real GDP Growth (%)
100% 10%
80% 8%
60% 6%
40% 4%
20% 2%
0% 0%
-20% -2%
-40% -4%
-60% -6%
2000 2002 2004 2006 2008 2010 2012 2014 2016
Source IMF World Economic Outlook, April 2018Fisch Asset Management Brazilian Presidential Election | 08/15/2018 Page 3 | 6
The candidates
At this time, we see three front-runners in the election: Geraldo Alckmin, Jair Bolsonaro and
Fernando Haddad. Other possible winners include Marina Silva and Ciro Gomes, but although
early to tell, we do not see them as real possibilities at the moment.
In our view, a victory by Alckmin would be the best case scenario for the market. We see
Alckmin, a relatively center candidate, as the most predictable, and at this time, predictability
would be exactly what investors need. Alckmin’s experience in Brazilian politics and relation-
ships within the congress would increase the likelihood of key reforms, of which something
Brazil is in dire need. Although supported by the markets, Alckmin has some key hurdles to
overcome during the election as many Brazilians associate him with Temer and the current
government. If he can overcome this association and make it to the run-off stage, we believe
Alckmin has a real chance of winning.
After Alckmin, we see Bolsonaro as the next best case marketwise. A career military politician,
Bolsonaro is positioning himself as the anti-left candidate and the only true opposition (de-
spite having been in the congress for over 20 years). We see him as a positive candidate from
an economic perspective, especially in the short-run, due to his intention of placing Paulo
Guedes, an economist from the University of Chicago, as his Treasury Minister. However, we
are concerned by Bolsonaro’s ability to pass reforms in the congress due to his lack of alliances.
We also see Bolsonaro as a wild card, especially in the long-run, given his affinity with the
military regime, debatable morals and unpredictable personality. Worth noting that he has a
high rejection rate as many Brazilians view him as a questionable character, something that
would be particularly concerning in a run-off round. Ultimately, Brazilians will have to weigh
whether a change in government and economic improvement will be worth a possible rever-
sion in social policies.
Finally, from the three likely outcomes, we see Haddad as the worst one among the three.
Given the past track record of the Workers Party (Partido dos Trabalhadores; PT; the party of
the impeached Rousseff and jailed Lula), we have some definite concerns over Haddad. Alt-
hough he has publically supported the need for some reforms, we are concerned over PT’s
willingness to pass certain reforms, especially given the short-term impact on its supporter
base. Additionally, PT has a history of interfering with quasi-sovereigns and other corporates
and using them to implement policies; for example, Rousseff controlled Petrobras’ prices at
the pump to help curb rising inflation. Haddad did have a high disapproval rate as the former
mayor of Sao Paulo; however, Lula’s supporters could back him providing a boost in a run-off
scenario.
With that said, the elephant in the room remains Lula (Haddad is currently discussed as PT’s
back-up plan). When included in polls, Lula comes out as a clear favorite. However, we are not
currently entertaining a scenario where the former president would be allowed to run by the
authorities. If this were to happen, we believe he would have a real chance of winning, some-
thing that we would definitely see as negative for the market. We will be following closely the
electoral authority’s decision regarding this candidate, an overhang which we are hoping will
be cleared still in August or September.Fisch Asset Management Brazilian Presidential Election | 08/15/2018 Page 4 | 6
Potential impact on Brazilian issuers
Regarding companies, the credits that would be most affected by the election outcome are
the quasi-sovereigns, in our view. These include Petrobras, Banco do Brasil and Eletrobras,
which together account for 2.4% of the EM index (note that 100% owned institutions such as
BNDES and Caixa are not eligible for the corporate index). The role that these companies are
to play in the next president’s policies will be crucial; for example, whether Petrobras is al-
lowed to continue charging market prices at the pump is a game-changing question. Further-
more, further privatization of Eletrobras or at least less interference can help the company
recover after a challenging period. We do not expect the market to respond positively at all to
government interference. Ultimately, the biggest risk is a possible nationalization, or manipu-
lation of operations, in addition to corruption, as experienced with the previous government.
The candidates that we are most concerned about regarding such possible interference would
be Haddad and Gomes.
Financial institutions in Brazil would also be affected by the outcome of the election. In addi-
tion to general domestic demand, banks would be impacted by possible distortions in interest
rates and credit policies. In case a socialist candidate wins, private banks could be harmed by
manipulation of interest rates, inflated public banks and liquidity problems, as we have seen
in the past. It is worth noting that the private Brazilian banks within our space, such as Itau
and Bradesco are among the largest and most established in the country and have experience
navigating volatility, but risk re-pricing would likely occur if PT is elected. As a reference, banks
account for 1.6% of the EM index (0.9% excluding Banco do Brasil).
We also expect private corporates to be affected, but to a smaller extent than the previous
two groups. While domestic demand, FX and local regulation do impact corporates across the
board, companies in Brazil are used to operating in a volatile economic environment, espe-
cially after the last couple of challenging years. Additionally, many companies within our uni-
verse are multi-nationals or exporters that depend on global demand. For example, protein
companies like JBS, Marfrig and Minerva could benefit on the export side. Additionally, mining
companies like Vale and Nexa depend on global commodity markets more than local demand.
As none of the three likely candidates are using strong rhetoric regarding intervention in the
private sector or pursuing an isolationist policy, we expect corporates in Brazil to survive these
elections relatively unscathed after some volatility. This can create opportunities as an inves-
tor, as high-quality credits can be relative safe havens in such an uncertain environment.
The road ahead
Ultimately, Brazil has an important choice to make, and with such a wide range of candidates,
the country is at a crossroads. Unfortunately, Brazil struggles to distance itself sufficiently from
those political ideologies that have served it poorly in the past. The fact that Lula is even in
the discussion, let alone being in the lead, is not only maddening but also incredulous to many.
However, as a Brazilian, it can be understandable why a frustrated population experiencing
high inequality may choose such a course. Having said that, we view that enough of the pop-
ulation has opened its eyes to the consequences of a long-running PT government, and are
hoping that a change in government will take place.Fisch Asset Management Brazilian Presidential Election | 08/15/2018 Page 5 | 6
Figure 2: Evolution of Brazil sub-index’ spread difference to the CEMBI Broad Diversified
Index (in bps)
600
500
400
300
200
5-year Average
100
7-year Average
0
Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 Jul 18
Source Bloomberg, August 14, 2018
The months leading up to the elections will provide plenty of opportunities in the face of what
we expect to be heightened volatility. At the end of the day, Brazil remains a natural resource-
rich country and an index heavyweight, and as such should be anything but ignored. We are
currently market-weight in our portfolios, a positioning we expect to retain until we begin to
get better visibility on which path Brazil will chose in the coming elections. The above graph
shows that current valuations are appropriate and are pricing in a reasonable election out-
come. However, the graph also shows what can happen if things were to go awry again when
political risk spikes. Ultimately, we like idiosyncratic risks at Fisch, and these elections will
bring exactly that.Fisch Asset Management Brazilian Presidential Election | 08/15/2018 Page 6 | 6
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