The election of the former army captain and self-styled political outsider, Jair Bolsonaro, has brought about the first right-wing Brazilian government since the military dictatorship ended in 1985.
The Tropical Trump, the moniker given by international press, promises to tackle corruption, crime, and economic irresponsibility. In order to take care of the latter, Bolsonaro has assembled a team of orthodox economists headed by the co-founder of investment bank BTG Pactual, Paulo Guedes, which also includes respected former finance minister Joaquim Levy.
Bolsonaro has promised to cut the 'bloated state' and on his first day of office he reduced his cabinet from 29 ministries to 22; whilst Paulo Guedes plans to ramp up the privatisation effort, selling SoEs and raising up to $260 billion.
Alongside a strong economic team, perhaps more importantly, Bolsonaro has a recovering economy on his side. Unemployment is gradually falling, whilst inflation and interest rates remain at all-time lows. Both individual and corporate debt have contracted considerably since peaking in 2014, unemployment is slowly declining, whilst disposable income is rising.
This is positive for the consumer and businesses, particularly those companies looking to make Capex, which in real terms has fallen to pre-08 levels. The consumer and industrial companies are expected beneficiaries, alongside Brazilian banks such as Itau, as after almost 4 years of negative real loans growth credit origination is finally beginning to expand. This should ultimately bring about growth for the Brazilian economy.
However, one of the main challenges Bolsonaro and his team face is the passing of a pension reform. This is crucial for the long-term state of the country’s finances. Equity valuations are richer than 6 months ago, indicating market expectation for pension reform and growth for 2019 is reasonably high. The near-term outlook for Brazil remains positive based on the backdrop of an improving economy, but for real long-term growth the political stars need to remain aligned, so failure to deliver leaves room for some disappointment.
The Somerset EM Small Cap Fund, managed by Citywire AA-rated Mark Asquith, currently has a 17.7% weighting to Brazil, compared to 6.5% from the MSCI EM Small Cap index and 7.4% from the MSCI EM index.
The fund’s Brazilian weighting was a positive contributor to relative performance in 2018 and has also been a positive contributor so far in 2019. Among its biggest drivers of performance last year were auto insurer company Porto Seguro and textile and retail clothing company Cia Hering.
Kumar Pandit is a senior analyst at Somerset Capital. The Somerset Emerging Markets Smaller Companies fund has returned 55.5% over three years compared to a sector average of 39.3%.