Brazil's tightening presidential race could drive a sharp repricing of local equities.
A new Goldman Sachs survey of 70 global investors found that half see at least 20% upside in EWZ, the US-listed Brazil equity ETF, by year-end if right-wing challenger Flávio Bolsonaro defeats socialist President Luiz Inácio Lula da Silva. The first round is scheduled for Oct. 4, with a potential runoff on Oct. 25.
Goldman Sachs Managing Director Nelson Armbrust provided clients color on the upcoming elections in South America, which could cement a historic, once-in-a-generation rightward shift across the continent.
Related:
He focused on positioning:
Flávio Bolsonaro (right-leaning candidate) is gaining momentum; polls show him tied or closing the gap in the second round.
As a reminder, pools don't adjust for the likely voter (aka: the people that actually turn up on the day to cast a vote, no mail ballot votes in Brazil), and historically there has been higher absence from Lula's voters.
We just did a survey with 70 global investors about their cross-asset views in Brazil, the bottom line:
- Equities is the least owned asset class (60% are either "very light" or "light") and it is the vehicle this group sees the most upside (half see EWZ at least +20% by year end if Flavio wins) From my convos, local Equity investor positioning is a 6/10 while local Macro accounts are small in equities (3/10).
Foreign capital is starting to come back to Brazil as we near the event:
We have seen massive buying of upside from investors, EWZ Call Open Interest at ALL TIME HIGHS:
Implementation: I like EWZ Call Spreads for November (runoff is October 25th) and going long our Rate Sensitive basket (GSBZRATE Index).
Implied 2 month vols have risen from ~30v to ~45v and past election cycles (noted on the graph below) show that vols could keep moving higher.
But the cost of the 30% delta call vs the 10% delta call has been stable lately and is historically cheap (21st percentile).
EWZ Nov 42 50 call spread = $1.00 offer 8x max payout, ref 37.20, ~45v ATMF, 23% delta, max loss is premium paid.
Another way to implement is going long GSBZRATE Index, they are the 30 stocks in Ibovespa most correlated to 5y rates. It is composed of Fins (38%), Real Estate (17%), Industrials (17%), Utilities (12%), Cons Disc (9%) and Materials (6%). You can trade U$75mn a day at 10% volume.
Brazil has the highest real rate in the WORLD (~10%) and is the most correlated EM Equity with local Rates. If rates come down, the move in Equities could be meaningful.
Below is a chart of the basket's P/E vs local short-term rates (Jan29 rates) inverted. As flagged by Louis Miller, one could expect a ~30%+ re-rating in GSBZRATE (P/E going from 9x to 12x) if the local rates price in 200bps of cuts – from my investors discussions, 200-300bps is where most expect to see short term rates by year end if Flavio wins.
Historically when the market prices cuts, our Brazil Rate Sensitive Basket delivered ~3x the Ibovespa's return (table below). The basket struggles if rates are cut due to recession risk or if there is a commodity boom (1/3 of Ibovespa is commods). Quick explanation below on periods the basket did not outperform Ibovespa (and I don't expect any of these scenarios to play out):
- Jan2010-Aug2010: economy and inflation were strong, CB started hiking and we had a bull flattening of the curve so the ongoing 5y came down.
- Jan2014-Aug2014: CB finished a hiking cycle on April 2014, economy started to decelerate sharply, mkt read it as "CB wont be able to keep rate high for long" so the 5y came down. Also, 2014 was an election year with Dilma x Aecio Neves (mkt thought Aecio, a right-leaning candidate, would win… but he lost and Ibovespa finished flat on that year.)
- Dec2015-Apr2018: huge commodities boom from China expanding, so Vale and Petrobras led the rally. Also in Aug2016 Dilma was impeached and Temer ran the country. During this time, markets rallied.
Earlier this month, Polymarket showed Bolsonaro overtaking Lula for the first time, and that lead has held through Saturday morning. Bolsonaro's odds of winning currently stand at 57%, while Lula's are around 42%.
Brazilian stocks have rebounded alongside rising Polymarket bets on a Bolsonaro victory.
A Bolsonaro win would cement a rightward shift after socialists spent years destroying the continent with nation-killing progressive experiments.
Also, across the pond in Europe, Nomura analysts expect an 18-month election cycle that sees the continent "lurching right."