Goodbye Dilma, Hello Brazil?
Brazilian senators voted to impeach an elected president for the second time in less than a quarter-century. And while many investors took positions before the event -- making the real the best-performing emerging-market currency this year -- latecomers were still entering the market. History suggests they may not be too late.
The spread on Brazil's five-year credit default swaps, the best way to insure a portfolio against the possibility a nation will stop paying its debt, dropped 26 basis points over the past two days, while the yield premium on the nation's dollar bonds due in 10 years declined 18 basis points.
This indicates that while there was a consensus that Dilma Rousseff's days as president were numbered, some global investors weren't buying the notion of deep changes to come. (In their defense, while the president is being removed from government, she has a chance to persuade lawmakers in the next 180 days that she should return.)
If the vote helped sway more investors, there might be a further rally in Brazilian assets, especially bonds. Brazil's notes due in 2026 paid a yield 364 basis points higher than 10-year U.S. Treasuries. That's far less than the 539 basis points the notes due in 2025 were returning back in February. It's still 64 basis points more than Paraguay's securities maturing in 2026 offer. Both countries are rated BB by S&P Global Ratings, but Brazil's economy, at $2.4 trillion, is 78 times bigger than that of its landlocked neighbor. Russia, which is much more dependent on a single commodity than Brazil, is paying a yield premium of 195 basis points on its dollar bonds due in 2023.
Traders, however, are betting that the smart money is in local securities. Inflation-linked bonds in real sport the highest one-year breakeven rate -- the difference between their yield and the yield on a regular bonds -- among major countries.
Verde Asset Management, one of the nation's most successful hedge funds, led by Luis Stuhlberger, told clients in its April report that it expected real rates to drop with the new government, creating profit opportunities in local bonds.
Verde also said it was betting the currency would stay in a narrower band, while it didn't see much upside in stocks. The benchmark Ibovespa index is up about 40 percent in dollar terms so far this year and is trading at about 14 times estimated earnings, slightly higher than the five-year average for the gauge but way below the peak of 19.1 times reached in October 2013.
A major negative is the economy, which contracted 5.9 percent last year. Economists surveyed by Bloomberg expect it to shrink 3.7 percent more. Inflation is still running at 9.3 percent, just off the 12-year high of 10.7 percent hit in December.
Beware of looking in the rearview mirror, though. John Maynard Keynes said business decisions, whether on output or investments, are largely dependent on the expectations of entrepreneurs.
A change in political direction may cause a shift in expectations that could boost the economy. There's a precedent: In December 1992, then-president Fernando Collor de Mello resigned on the eve of being impeached by the Senate. The next year, the economy grew 12.2 percent and that pace was doubled in 1994 as an economic plan by incumbent Itamar Franco stabilized the currency.
That doesn't mean the same will happen again. Yet for the first time in the past two years, there seem to be a lot more bulls running around Brazil than bears.
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