2020 was certainly an anomalous year for all stock exchanges, due to the coronavirus pandemic and the economic crisis that followed.

Making a comparison between the forecasts at the beginning of 2020 and the actual results at the end of the year would be a rather useless and ungenerous exercise, given that all the premises were swept away already at the end of February.

As a curiosity, however, I transcribe what was written by XP Investimentos at the end of December 2019. I also wanted to put the link to the page, but it was wisely deleted:

“2020 starts with great optimism, the Real is appreciating against the dollar and the Ibovespa is at an all-time high, surpassing our closing forecast of 115,000 points. The Selic discount rate was reduced in December to 4.5% per annum, the lowest level in its history.

Our expectations are still very positive, especially for the equity market, as companies are the main beneficiaries of lower interest rates. Premiums on credit assets are still high.

In front of us, the horizon is clean and open. The necessary preparations have already been made and now Brazil is ready to take off. “

On 23 January 2020, Ibovespa had reached its all-time high (119,527 points) and the market expected a year of growth, albeit moderate (+2%), of the Brazilian economy. Although the pension reform was approved, the political terrain remained rough, with the Bolsonaro government always seeking parliamentary support for new reforms and privatizations.

On February 26, with the discovery of the first case of coronavirus in Brazilian territory, Ibovespa closed with a heavy loss of 7%, at 105,718 points.

That first thud was followed by several negative sessions, up to the 2020 low on March 23 (63,569 points): -46% from the beginning of the year.

From that moment a gradual recovery began, albeit with ups and downs, which led the Ibovespa to close the year at 119,017 points, thus fully recovering the losses suffered in February / March.

But let’s see the trend of the Bovespa Index (Ibovespa) from January to December 2020:

+ 0.4% of the value expressed in reais

– 29% in euros

– 22% in dollars

Bovespa therefore closed essentially at breakeven in terms of local currency, but considering inflation (+4.5% in the period considered), those who invested in the stock market saw their capital erode.

However, it is clear that the devaluation of the real against the dollar and the euro has strongly influenced the result in foreign currency. The weakening of the dollar against the euro, which began in mid-2020 and accelerated with the election of Biden, has led to an increase in losses measured in European currencies compared to those in dollars.

Here are the prices of the real against the dollar and euro:

 early 2020end 2020

And here is a comparison of the performances of Bovespa, Dow Jones and FTSE Mib (Milan stock exchange) in 2020:

 early 2020end 2020Change in US$Change in EuroChange in Reais
Dow Jones Index28634306067%-2%38%
FTSE MIB23702222322%-6%33%

Those who invested 10 thousand dollars in the Brazilian stock exchange in January 2020, at the end of the year found themselves, gross of various commissions and taxes, about 7800 dollars. Bad investment, due exclusively to the devaluation of the real against the dollar. He would have done better by leaving the money under the mattress, given that the US stock exchange recorded a gain of +7% in dollars. (We are not talking here about other investments like gold and silver, superstars in 2020).

The situation was different for those who had invested their reais in the two foreign stock exchanges: the earnings, in Brazilian currency, would have been considerable (+38% in New York and +33% in Milan).

I remember that the value of the basket of shares that constitutes the Ibovespa is strongly concentrated on some blue chips very sensitive to political events and to the change in macroeconomic factors:

Itau (Itausa and ItauUnibanco): 14.23% of the index

Petrobras (ON and PN): 11.45%

Bradesco (ON and PN): 9.90%

Vale (ON and PN): 5.80%

The dangerous race for higher returns

In 2020 the discount rate (SELIC) reached its historical low: 2%. Considering that 2020 inflation was equal to +4.52%, real interest rates have long been positioned in negative territory.

It is an extremely anomalous situation for Brazilian investors, accustomed to high interest rates and therefore to yields much higher than the world average even on low-risk securities.

This situation has led to two certainly not negligible phenomena: on the one hand, a massive shift of liquidity from fixed-income securities (government bonds, certificates of deposit, savings books, etc.) to variable-income securities (in particular securities shares), on the other hand to a greater difficulty in financing the public debt by the Brazilian Treasury.

This phenomenon is causing a valuation of equities without necessarily being justified by an increase in their profitability. In fact, if we observe the trend of the P/E indicator (share price / earnings per share) of the shares listed on Bovespa over the last 5 years in the graph below, we see that starting from November 2020 its value suddenly increased from 15 to 22.

(source: OCEANS14)

If we consider that the P/E of the shares listed in the S&P 500 index is today at 38 and the NASDAQ at 26, the value of the shares listed on Bovespa may not seem overestimated, but – given the historical trend and the Brazilian macroeconomic situation certainly not very rosy – it is legitimate to question whether a “bubble” is being created in the stock market.

However, Bovespa’s performance was among the worst in the world in 2020, also due to the fact that its index is largely made up of companies in the cyclical (transport, tourism, commodities, real estate, etc.) and financial sectors, those most affected by the economic crisis. This could support share prices thanks to sustained increases in profits in 2021.

The flight of foreign investors continued into 2020

The Brazilian stock market is increasingly in the hands of Brazilian investors. The exit of foreign investors continued in 2020: the negative balance was -64 billion reais in the January-October period (in the whole of 2019 the balance was -45 billion reais).

Foreign participation in the secondary market (thus excluding IPOs and new issues) is equal to 48% of the total. An additional figure that demonstrates how Ibovespa’s performance in 2020 was supported by the internal market.

However, it should be noted that the trend was reversed in the months of November and December 2020, in which foreign investors returned strongly.

The scenarios of 2021

a. International economic scenario

Thanks to mass vaccination and the expansionist policies of the major economies, a strong recovery is expected in 2021. For Brazil it means a potential growth in exports of its commodities and related prices, as well as a greater flow of investments from abroad. In 2021, expansionist policies are expected to be maintained, with liquidity injection by central banks and still very low interest rates, factors that should favor a flow of investments to emerging countries.

b. Internal economic scenario

After a decline of close to -4.5% in 2020, economists are predicting Brazilian GDP growth in 2021 around 3.5%. With the end of the “auxilio emergencial”, which allowed the survival of the poorest families and sustained consumption during the most difficult months of the economy, and unemployment at 14%, the first months of 2021 will be crucial for the economy. If the hoped-for strong recovery does not take place, the government would be forced to renew aid to the population with serious consequences on the country’s fiscal balance. The return of inflation is also a problem that could worsen in 2021 and that could lead to a significant increase in the discount rate by Banco Central.

c. Internal political scenario

For the recovery of the economy to be solid and consistent, it is necessary to carry out the pending reforms, of which tax and administrative are the most urgent. The “window” to discuss and approve them, however, is limited to 2021, given that 2022 will be the year of presidential elections, in which it is unlikely that reforms will be approved. It will be necessary to see if there will be the political capacity (and real will) on the part of the government to push through even unpopular changes to increase the efficiency of the state machine. Already now Bolsonaro has to manage a decline in popularity due to the mismanagement of the pandemic; if the economic situation worsens it will be almost impossible for him to defend unpopular reforms in view of the 2022 elections.

d. Exchange

2020 was a year of strong devaluation of the real and several economic operators expect its revaluation in 2021. BNP Paribas expects the dollar to close 2021 quoted at R$ 4.25 (at the end of 2020 it was quoted at R$ 5.19). Much, however, will depend on the progress of the fiscal deficit and the approval of the reforms by Parliament.

What to expect from the Brazilian stock market in the coming months?

XP Investimentos writes, in its December 2020 report (https://conteudos.xpi.com.br/brasil-2021/brasil-2021-de-volta-aos-rumos-do-crescimento/:

“We forecast a fair value for Ibovespa of 130,000 points by the end of 2021, providing a potential return of 14% compared to current levels.

Despite the recent strong recovery, Brazilian equities are still far behind and the index is among the worst globally in 2020. Furthermore, the MSCI Brasil and Ibovespa indices are heavily concentrated in companies from cyclical sectors and the financial sector, which should benefit from a resumption of global growth and the continuation of the reopening of trade”.

Although the pandemic continues to claim many victims in Brazil, thanks to vaccinations, the health crisis should ease in the coming months and allow for a gradual return to normal. The real unknown concerns the resilience of the economy and above all the government’s ability to implement the necessary policies and reforms without causing a fiscal crisis that would jeopardize a rapid exit from the crisis.

Unlike the more developed countries, which have the financial “arsenal” necessary to restart the economy, Brazil must face 2021 with the hope that it is above all the private sector that is the protagonist of the recovery.

To decide on a possible purchase of Brazilian shares (in general) it is prudent to wait at least until the end of February 2021, after the election of the Presidents of the Chamber and Senate and when it will become clearer whether or not the government will have to re-propose the “auxilio emergencial”.

If the most optimistic scenario were to be confirmed (alignment of Parliament with the Bolsonaro government and no need for new transfers to the most needy families), the stock market has a good chance of growth, even higher than that envisaged by XP Investimentos.

Among the stocks with the greatest growth potential, we highlight those in the financial sector (Itaù, Bradesco, Banco do Brasil, and those related to the tourism / travel sector.

 Note: those interested in the historical trend of the daily prices of the Bovespa index, real / euro and real / dollar exchange rates of the last four years, can receive it for free in Excel format by requesting it from: info@updatebrazilconsulting.com