Bloomberg — After embracing Jair Bolsonaro’s anti-establishment stance just four years ago, investors are now warming to a very familiar face in Brazilian politics: Lula.
Money managers are piling into the nation’s assets, sending the currency to the highest level since July and fueling a world-beating rally in stocks after a horrible year for both. The inflows come on the back of aggressive interest rate hikes that have sent yields soaring and even as Luiz Inacio Lula da Silva, the left-wing leader who ran he country two decades ago, mounts a comeback.
Lula, who leads early polls for the October vote, hasn’t given a clear direction of his core economic policies yet. While his advisers point to more spending if he is elected, investors are betting on his pragmatism and signals toward moderation, much like he showed in his first election in 2002.
Back then, they had initially dumped stocks and bonds on fears that he would default, but were reassured by his pledge to honor the country’s sovereign debt and keep the nation’s fiscal accounts in check -- and went on to reap gains in almost all of his eight years in office. The shine wore off as his Workers’ Party was engulfed by corruption scandals that landed him in jail and his handpicked successor, Dilma Rousseff, throttled economic growth with an ever-growing web of restrictions and controls.
“Lula is the devil that we know,” said Edwin Gutierrez, the head of emerging-market sovereign debt at abrdn in London. “He’ll say things that will upset the market from time to time regarding energy prices and the role of the state, but overall, he isn’t going to mark a return to the Dilma era.”
The Brazilian real has strengthened more than 9% against the dollar this year, the most among all currencies in the world, despite the escalating conflict in Ukraine that has sapped risk appetite. Foreign investors added over 56 billion reais to the local equity market this year ($11 billion), helping to send the Ibovespa benchmark index up 15% in dollar terms. Offshore money has poured into Brazilian stocks for every single session since mid-December, the best run since at least 2008.
The perceived decline in local political risk has added to optimism with Brazilian assets, which were already becoming more appealing to foreign money amid rising yields and cheap valuations. Even after the recent rally, the Ibovespa is trading at 8.3 times forward earnings, well below its 10-year average of 11.7. Meanwhile, the central bank is expected to raise rates to above 12% in the coming months, up from 2% a year ago.
“Foreigners return to Brazil from time to time, doing the same trades and causing the same market distortions,” said Felipe Guerra, founding partner at local hedge fund manager Legacy Capital, at an event earlier this month. “Then they go away and leave us” with the problem, he said.
But even locals, who haven’t been as bullish as foreigners, are turning more optimistic. Brazil-based funds trimmed their long dollar hedges by $2.6 billion since Jan. 3, according to local exchange data compiled by Bloomberg.
The warm welcome for Lula is nothing like last year, when markets briefly panicked on the prospect he would run for office again after a judge tossed out criminal convictions against him. Signs the former union leader may be elected also sent chills through markets in 2018, when he was ultimately barred from running, and in 2002, when investors sent stocks and the currency down as much as 40% in the year and ditched the nation’s bonds amid default concerns.
This time, it took Lula only a hint of moderation to convince investors that his third mandate wouldn’t be this harmful for the economy and markets. In between criticism of state-run oil company Petrobras and comments on reviewing the nation’s labor laws, the former president signaled he could tap centrist former Sao Paulo governor Geraldo Alckmin to join his ticket as vice president. The nod to a moderate running partner sent the real rallying.
“Lula’s smart enough to know what he has to say in order to get the market comfortable,” said Cathy Hepworth, head of emerging markets debt at PGIM Fixed Income. “He’s done this before.”
Overseas investors were also encouraged by similar episodes in Chile and Peru, where recently elected leftist presidents toned down their speeches after winning.
Despite the rally, a sluggish recovery in Latin America’s top economy, double-digit inflation and potential for further public spending ahead of the October vote still pose risks. Incumbent Bolsonaro has flirted with additional expenses as he seeks to boost his approval ratings ahead of the election.
Chances of winning
Lula has led most election polls since he was cleared to run for office early last year and political consultancy Eurasia gives him a 70% chance of winning.
During his tenure, a surge in commodities and orthodox picks for the economy ministry and the central bank helped keep fiscal accounts in check and catapult Brazil to market-darling status. The former president oversaw a 113% rally in the real, the best-performing emerging-market currency in the span. Stocks surged six-fold in his eight years in office.
Meanwhile, Bolsonaro, who rose to power in 2018 on an anti-establishment, anti-left wing platform, has been struggling as inflation eats into Brazilians’ purchasing power and the economy posts lackluster growth.
In the 2018 election run-up, markets rallied on bets Bolsonaro would seek to shrink the size of the state and approve a series of economic reforms. While he delivered some promises -- including a much awaited overhaul of the pension system -- he also spooked markets by spending big during the pandemic.
“Bolsonaro would be an A-, if he has a second term. Lula is more of a B, but I don’t think he’s going to be a D,” said Jason Devito, a Pittsburgh-based money manager at Federated Investment Management Co., which has $669 billion under management. “I’m not expecting a disastrous outcome here.”