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July 2022


Is Lula`s Comeback a Real Threat to the Brazilian Economy?

A little more than a year has passed after the decision of a Brazilian judge overturned Luiz Inácio Lula da Silva criminal convictions and reinstated his right to participate in the next Brazilian election on October 02, 2022.

Former President Lula Da Silva is ahead in the polls and maintaining a lead over incumbent Jair Bolsonaro.

Lula drew 47% support in the opinion poll against Bolsonaro`s 28%. (Datafolha opinion poll released 6/23/2022).

The polling results suggest time is running out for other candidates as the candidate in third place had only 8% support from the voters.

Investors’ worries reflected not only the risk of a Lula victory but also the concern that, if the case arises with an electoral challenge from his old nemesis, Bolsonaro would abandon his market-friendly reforms and lean towards a more populist approach.


Commodities Under President Lula

We have four reasons to believe that Lula`s return (if he occupies presidency again) should not be feared. In our opinion,

    1. Brazil should be an attractive play on the commodity upcyclewith cheap equity valuation vs history. Commodities are once again a tailwind for Brazil, which could overwhelm poor politics. Agricultural, iron ore, and petroleum are key products for the recovery in Emerging Markets, thus Brazil.
    2. During Lula`s tenure from 2003 to 2010, the commodities super-cycle outweighed concerns over the socialist party at that time, which easily could be repeated.
    3. Congress is already highly fragmented and this would impede even the toughest reform efforts by the executive branch.
    4. The MSCI Brazil Index* now trades at a forward P/E ratio** of 5.1x and is designed to measure the performance of the large and mid-cap segments of the Brazilian market. The index covers about 85% of the Brazilian equity universe, which is below that seen at the peak of the Global Financial Crisis in 2008. Such incredibly cheap valuations contrast with the relatively low degree of country risk, as shown by low credit default swap spreads in Brazil. (It is not possible to invest directly in an index)

All these aspects give us a clear idea that election risks are somewhat priced into current equity market valuations.

Politics is already a headwind and if the commodities tailwind persists then the precedent of his last presidential mandate suggests Lula`s return should not be so feared.

This opinion article was written by Mauricio Alvarez, Portfolio Manager of OTG Latin America Fund as of July 2022.
*MSCI Brazil Index MSCI Brazil Index (USD) is designed to measure the performance of the large and mid cap segments of the Brazilian market. With 48 constituents, the index covers about 85% of the Brazilian equity universe.
** Forward P/E Ratio (Forward price-to-earnings) is a version of the ratio of price-to-earnings (P/E) that uses forecasted earnings for the P/E calculation. P/E  is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.