Oct. 26 (Bloomberg) -- Brazilian stocks are inexpensive even after a 73 percent rally for the Bovespa index this year and cutting allocations may be “hazardous” for investors, Goldman Sachs Group Inc. said.

“Forward valuations suggest it is hazardous to be underweight Brazil,” Stephen Graham, a Sao Paulo-based analyst wrote in a note to clients. “Brazilian sovereign risk and interest rates are at or near record lows, while prospects for sustainable economic growth are possibly better than at any period in the last few decades.”

The Bovespa may top 85,000 by the middle of next year, he wrote. That represents a 31 percent gain from the close on Oct. 23. The index trades at 16.5 times estimated earnings, compared with 17.16 times for the MSCI Latin America Index, according to Bloomberg data.

Earnings per share will likely grow 46 percent next year and 23 percent in 2011, meaning that forward valuations will remain steady even as the index climbs to 85,000, Graham wrote.

The index was little changed today, climbing less than 0.1 percent to 65,085.55 in Sao Paulo.

The Bovespa is poised for its biggest annual gain in six years as the economy recovers from the first recession since 2003, bolstered by record-low rates and increased domestic demand. Economists forecast that Brazil’s gross domestic product will expand 4.8 percent next year after growing 0.18 percent in 2009, according to the median forecast in an Oct. 23 central bank survey of about 100 analysts published today.

‘Baby Boom’

A “baby boom” in the 1980s means consumers in their 20s are now entering the market with “credit volumes never before available,” driving up demand in Brazil’s domestic market, he wrote.

The growth of the population may lift Brazil to the world’s third-biggest market for computers and telephones next year, Graham wrote. the country’s “financial stability” has led to 77 percent growth in bank accounts over seven years and 18 percent growth in the number of credit cards since 2001, the strategist wrote.

Preparations for the 2014 World Cup and 2016 Olympic Games will likely speed up financing for needed infrastructure projects, Graham wrote. Brazil is seeing “some of the largest build-outs in the world underway in power transmission, pipelines, hydropower, and telecom,” as global attention from the sporting events puts pressure on the government to accelerate the pace of construction, he wrote.

Latin America’s biggest economy is also at an advantage to other commodity-producing nations because it sells to “fast- growing” China instead of relying on sales to slower-growing markets in the U.S. and Europe, Graham wrote.

To contact the reporter on this story: Paulo Winterstein in Sao Paulo at pwinterstein@bloomberg.net.

Last Updated: October 26, 2009 16:49 EDT