Brazil: Potential Positive Asymmetry Into the October Election

Brazilian equities offer positive asymmetry into the October election because depressed valuations, high real rates, easing monetary policy and limited political downside outweigh the risk of further short-term volatility.

• Brazilian equity indices provide a counterweight to AI-driven U.S. mega-cap exposure: commodities represent 37% of the MSCI Brazil Index and 30% of the Ibovespa, while domestic banks represent 40% and 28%, respectively.
• Foreign investors withdrew about BRL 3 billion from Brazilian equities during August 11–18, following a BRL 4.7 billion single-day outflow; the resulting monthly outflow ranks as the third-largest since 2008, but current fundamentals do not resemble the Covid shock of 2020.
• The MSCI Brazil Index trades at 8.3x forward earnings versus a 10-year average of 9.7x, while its dividend yield is about 7.0% versus a 10-year average of 5.6%, implying that political risk is already reflected in valuations.
• Brazil’s real interest rate is approximately 9.3%, supporting the currency through carry demand even as equity flows weaken, and the central bank has moved from peak Selic rates into an expected easing cycle.
• Global X’s analysis of seven completed rate-cutting cycles since 2000 found that equities rose in four, gaining an average of about 96.7%, while the three declining cycles produced an average drawdown of 14.5%.
• The October 4 first round and possible October 25 runoff are viewed as close contests; a Lula victory is considered largely priced in and constrained by Congress, while a decisive opposition victory could generate additional upside, as illustrated by the 7.8% MSCI Brazil rally after Bolsonaro’s 2018 first-round result.

Takeaway: The authors see a technically excessive, election-driven outflow rather than fundamental deterioration and prefer concentrated active exposure over passive beta because the index has more than 64% of its weight in ten names and contains significant governance and state-ownership dispersion.