Brazilian election

It is always difficult to predict the Brazilian election, as we saw with Marina Silva's dramatic defeat in round one on the 5th October. Brazilian polls are notoriously inaccurate, but if fellow emerging market powerhouse India is anything to go by, we are in for an enthralling finish. Since Narendra Modi and his BJP party took power in May, the Indian market has rallied by around 25%.
There has been optimism in the region surrounding Aécio Neves and his centre-right Party of Brazilian Social Democracy. He won 33.6% in the first round of votes but critics feel he has “struggled to persuade poorer Brazilians the reforms he espouses”^. However recent forecasts from the polling stations present a different story; “Aécio Neves has 45% of the total prospective votes heading into a runoff with President Dilma Rousseff of the Workers’ Party, who would garner 43%, according to polling firms Datafolha and Ibope”^^^

Under Ms Rousseff the economy has stalled and social progress has fragmented. “In June 2013 over 1 million people took to the streets to protest against poor public services and political corruption” ^^; recent data shows that Brazilian GDP growth rate stands at -0.6% and inflation levels are particularly high at 6.26 %, outlining the need for change to the economy.

Brazil's lack of basic transport infrastructure and state ownership prevents investment in many other industries. “It currently costs less to ship soy from a Brazilian port to China than it does to get the soy to the port from the farm”^^. If Aécio Neves is able to achieve a victory on Sunday, his free market reforms could prove to be a major economic catalyst. Neves has a proven track record as governor of Minas Gerais state, and has proved he can turn a financial basket case into a strong administration by cutting bureaucracy and appointing a strong team of internationally respected advisers. True, there are certain concerns prevailing in the Brazilian stock market including subdued growth estimates, along with surging inflation rate and speculation surrounding a possible further decline in commodity prices. If Brazil is to avoid another four years of drift, it is vital that Neves succeeds and in doing so revives investor confidence in a market which has struggled ever since the end of the commodities boom.

The widespread unrest and protests show the importance of winning over the poorer Brazilian demographic. This is where the election will be won and lost. In recent weeks the Brazilian working class has been showing renewed confidence in Aécio Neves. However, his campaign has recently been damaged by water shortages in São Paulo. The PSDB, which controls São Paulo state, “avoided introducing water rationing months before and President Rouseff attacked Neves on the issue during a televised debate on Thursday”**. The PSDB party dominated São Paulo (home to almost a quarter of all Brazilian voters) in the first round of the country’s elections this month. However, the capital's poorest residents have been hit hardest by the water shortage and there is a real possibility many may now switch their support to Rousseff's PT party.

Chelsea particularly likes the FundCalibre Elite Rated and Chelsea Core Selection Aberdeen Latin America Equity fund, of which 67% is invested in Brazil. This fund is well-positioned for a cyclical recovery and has overweight positions in energy, consumer discretionary and industrials. This is particularly suitable to Mr Neves' reformist ideas. His free market policies include boosting private investment in infrastructure and simplifying the national tax system.

Chelsea also likes another FundCalibre Elite Rated fund and Chelsea Core Selection, Matthew Vaight's M&G Global Emerging Markets fund. This fund might be appropriate if you are looking for an alternative with less exposure to Brazil, currently 11.3%* of the fund is invested in Brazil. The M&G Global Emerging Market fund identifies undervalued quality stocks with a bottom-up approach focusing on valuation anomalies created by short-term events, such as the Brazilian election.

A new president can be a major catalyst for emerging markets; the MSCI Brazil is down more than 20% over the past five years, but the market is still up 281% over 10 years!* That just goes to show how critical it is to get your timing right when investing in Latin America and that is why this election result will be watched so closely by investors.

If you would like to change your portfolio, you can do this in 3 ways:

*FE Analytics 03/10/2009-03/10/2014.
** http://www.ft.com/cms/s/0/9616e19c-55e4-11e4-a3c9-00144feab7de.html#axzz3Gf8pTnm5 19th October 2014
^ http://www.marketsemerging.com/which-way-brazilian-stocks-will-move-now-petroleo-brasileiro-petrobras-sa-adr-nysepbr-oi-sa-adr-nyseoibr-cemig-nysecig-ambev-sa-adr-nyseabev/1714539/  18th October 2014
^^ http://www.telegraph.co.uk/finance/personalfinance/investing/funds/11122180/High-risk-Isa-fund-tips-single-funds-that-back-China-Brazil-India-and-Indonesia.html 8th October 2014
^^^ http://online.wsj.com/articles/brazil-presidential-candidates-remain-in-dead-heat-1413410004  15th October 2014