China Slowdown Shouldn’t Put a Damper on Brazilian Stock Market, JPMorgan Says

Pedro Martins, Chief Strategist for Emerging Markets at the US bank, told Bloomberg Línea a new monetary easing cycle should drive stock prices

Photo: Bloomberg)
September 11, 2023 | 11:00 AM

Read this story in


Sao Paulo — China’s economic recovery has surprised to the downside in recent months, but that shouldn’t put a damper on investors’ optimism regarding the Brazilian stock market, according to Pedro Martins, Chief Strategist for Emerging Markets and Head of Equity Research for LatAm at JPMorgan.

In an interview with Bloomberg Línea, Martins put forward his view that monetary easing and improved fiscal conditions in Latin America’s leading economy are likely to offset headwinds brought about by reduced demand for commodities from the Asian powerhouse.

What Explains Brazil’s Surprising GDP Growth?

The Ibovespa (IBOV), the Brazilian stock market’s leading index, has a higher weighting of companies exposed to the commodities sector. For example, the mining company Vale (VALE3) alone accounts for about 15% of the index. Petrobras (PETR3, PETR4) accounts for another 12.7%.

“There are plenty of ways to express this optimistic view about the interest rate cut in Brazil without necessarily touching on China,” he said.


To be sure, Martins sees the monetary easing cycle as the main driver for the Brazilian stock market going forward. Under that view, he prefers sectors with a negative correlation to rate cuts. That includes companies with government concessions (electricity, roads, railways), rental companies (shopping centers, cars), and more cyclical sectors like construction and capital goods.

The current context is also favoring what he calls “growth enablers,” which are companies expected to see a strong increase in profit, including those in domestic consumption sectors like healthcare, education, and financial instruments related to the capital market.

The US bank projects that the Ibovespa (IBOV) will trade at 135,000 points by the end of the year in December, which would imply a potential upside of 16.4% compared to where it closed on Wednesday September 6. As for the Selic rate, the projection is for 10% per year, from 13.25% currently.


For this target price to be achieved, we would like to see, in addition to the cyclical component, improvements in economic growth expectations and the government’s ability to work towards a benign fiscal dynamic, with the debt-to-GDP ratio stabilizing,” he said.

Below are the key excerpts from the interview, edited for clarity:

China typically takes up a large portion of emerging market portfolios. How can the slowdown in its economy, coupled with the real estate crisis, affect other emerging markets?

China has indeed been a source of disappointment this year. One of the issues is related to the risk premium, which is the hardest to calculate. Investors’ inability to calculate this premium is due to both geopolitical issues [in the dispute with the US] and Chinese policies – the “common prosperity” and how it helps or hinders the risk perception in the stock market. These two factors have created a kind of foreign investor aversion to China. When the country is doing very well, the market normally has a neutral allocation to the country, which is a significant part of emerging markets, hovering around 35% of the index – 50% when Taiwan is considered. When investors have concerns, as is the case now, they tend to have an underweight allocation [below the market average]. The other aspect of the China discussion is the economic growth cycle, and in this regard, we started the year very well. From January to March, we had economic growth that exceeded expectations due to the post-COVID reopening. However, from the second quarter onwards, all of this began to disappoint. This has led to expectations for China’s GDP growth, which had once been above 6% for this year, now falling below 5%. For next year, which had also risen above 5%, it is expected to be near 4%.


What does this mean for the commodities sector and how does it impact markets like those in Latin America?

In general, it seems more interesting today to have exposure to commodities that have fundamentals divided between domestic consumption and investment, rather than those directly exposed only to investment, which is the Chinese part. In other words, it’s better to be in technology, semiconductors, and electronic components – which, unfortunately, we don’t have much of in Latin America – than in commodities like iron ore and steel. It also seems more attractive to be exposed to agricultural commodities – which is good for Latin America– than to those related to pulp and paper. In a world where China is growing, it usually benefits us in two ways: commodity prices and macro factors (flow, exchange rates, and carry [trade] in currencies). If we zoom out from China and look out more broadly, when the Asian powerhouse is doing well, it becomes easier to attract global equity resources to emerging market stocks. From January to March this year, global funds dedicated to emerging markets attracted $40 billion, which is a good number. But when China started to perform poorly, money stopped flowing into these markets. Global money, which was looking for an alternative to the US stock market, found it in Europe and in emerging markets in the first half of the year. Today, the preference is for Japan.

It’s interesting that Japan is considered an alternative to global investments. Why has the country gained such prominence?


Japan is managing to generate inflation this year – something they haven’t had in the last 20 years. By generating inflation, there’s a corporate aspect: pricing power, meaning companies can pass on costs and improve their margins. Moreover, it demonstrates some confidence in the Japanese consumer, who, for two decades, despite very low real interest rates, wasn’t spending. So what we have now is a favorable Japanese macroeconomic cycle, while, for the US stock market, concerns revolve around a valuation that is above historical standards.

US stocks have risen strongly this year, especially with the frenzy surrounding artificial intelligence. Is there room for further gains ahead?

The performance of the US stock market is heavily biased and concentrated in a small segment that consists of tech companies – and, if we take a closer look, it’s even more focused on those related to AI. The more technology-oriented stock exchange (Nasdaq) is rising twice as fast as the other (S&P 500), which is also performing very well this year. The bank’s view of the US stock market is not constructive. We have an underweight recommendation within the global equity portfolio. And the reasons for this are: 1) For the current nominal interest rate level in the US, we believe the price-to-earnings (P/E) ratio should be lower; 2) We don’t believe that next year’s earnings growth would justify the current valuation level the stock market has reached.

What does the scenario of higher interest rates in the US mean for emerging markets?


This means that, unfortunately, the competition for global allocation of resources will be more intense for a longer time. An ideal scenario for emerging markets is “not too hot, not too cold,” meaning you can’t be booming in the US or in a crisis because otherwise, money won’t flow into the country. But if we have a mild, moderate slowdown that generates very low return expectations, money begins to seek alternatives. The current direction is that the US will remain exceptionally strong for longer, which reduces the urgency for global allocators to look for alternatives outside the US. But the market is becoming more selective.Total assets in emerging market equity funds are close to $1.5 trillion. This amount compared to the total invested in global equities represents 6% of the total. The historical average is 9%. So, there is a huge underallocation level in emerging markets. However, for this reversion to the mean to occur, the US needs to phase out from an exceptionally strong moment, and there also needs to be an improvement in emerging markets, especially in China.

Can the impact of China on commodity markets serve as a headwind even in a more optimistic scenario for the Brazilian stock market with interest rate cuts?

The predominant factor for the Brazilian stock market to perform well right now is the prospect of falling interest rates. If we were at 13.75%, we believe we can reach 10% [per year] by the beginning of next year. And depending on the movement of US interest rates, it could be even lower. This movement is crucial for us to rebalance the valuation relationship of the stock market against its opportunity cost, which is fixed income. Today, the Brazilian stock market trades with a price-to-earnings ratio below its historical reference of 10.5x to 11x. Therefore, there is still a huge potential for multiple expansion, favorable to the rise in stock prices, mainly due to the movement of falling interest rates. There is a wide range of ways to express this optimistic view about falling interest rates in Brazil without necessarily touching on China. In the case of exporters, this scenario doesn’t help, obviously.


What is JPMorgan’s base scenario for the Selic rate?

The bank’s view is that we will continue with a rate cut of 0.50 percentage points (pp) until the end of the year, and then it will smooth out to cuts of 0.25 pp until the Selic reaches 10% per year. Obviously, all market participants are finely tuned. The two most important variables to monitor between Copom meetings are: how is Brazil’s economic activity level, and how is reported inflation and expectations for price indices.

What would make foreign investors prolong their interest in the Brazilian stock market?

The cyclical story is just beginning; we’ve had only one interest rate cut so far. Roughly speaking, in our studies, for every 1 percentage point interest rate cut, the stock market rises by 10% – the calculation won’t be exactly like that from where we are, because the market tries to anticipate. But our target price for the Ibovespa at the end of the year is 135,000 points. We have a reasonably positive outlook for the end of the year, and considering we have only half a year ahead, it’s a quite interesting return. For this target price to extend, we would like to see, in addition to the cyclical aspect, improvements in economic growth expectations and the government’s ability to work towards a benign fiscal dynamic, with the debt-to-GDP ratio stabilizing. This second factor is important because it provides a planning horizon. The stock market responds like the real economy: the more planning horizon you have, the more room there is for investment and resource allocation. We are starting with a very good, strong cyclical story that puts Brazil in a prominent position in the world of emerging markets amid this cyclical boost that will last until next year – and with the expectation that it becomes more sustainable in the long run.