Brazil’s New Government Is Promising Wall Street The Moon

&l;p&g;&l;img class=&q;dam-image bloomberg size-large wp-image-43213122&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;639&q; data-width=&q;960&q;&g; Jair Bolsonaro, Brazil&s;s president. His economic team is promising the moon. Photographer: Jason Alden/Bloomberg photo credit: &a;copy; 2019 Bloomberg Finance LP

Brazil is super great right now.

If you&s;re an investor.

It&s;s been four weeks since the inauguration of Jair Bolsonaro as Brazil&s;s new president and here&s;s just some what&s;s happened: mining company Vale made world headlines as &l;a href=&q;; target=&q;_blank&q;&g;one of its mines imploded &l;/a&g;for the second time. Over a hundred people are dead. People are still missing, probably buried under piles of mud and rubble. Some of the company&s;s chief executives face jail time.

A congressman named &l;a href=&q;; target=&q;_blank&q;&g;Jean Wyllis&l;/a&g; from the Socialism and Liberty Party (PSOL) quit because he said his life was in danger due to the fact that he is a left wing gay man in a right-wing government. Supposedly he is living abroad in self-imposed exile. Wyllis was replaced by David Miranda, also of PSOL, and the husband of American journalist Glenn Greenwald.

&l;img class=&q;dam-image bloomberg size-large wp-image-43222748&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;640&q; data-width=&q;960&q;&g; Rescue workers carry the body of a victim after a Vale dam burst in Brumadinho, Minas Gerais state, Brazil, on Saturday, Jan. 26, 2019. The stock collapsed once the news broke. Photographer: Victor Moriyama/Bloomberg photo credit: &a;copy; 2019 Bloomberg Finance LP

Bolsonaro&s;s son and new Senator, Flavio Bolsonaro, also &l;a href=&q;; target=&q;_blank&q;&g;made headlines&a;nbsp;regarding some&l;/a&g; corruption allegations. It&s;s a bad look for a president who ran on a law and order platform. Brazil watchers know the drill: sacks of money, and dubious bank accounts.

Famous Rio soccer club, Flamengo, saw its training facility burn down, &l;a href=&q;; target=&q;_blank&q;&g;killing 10 of their farm team players.&l;/a&g;

Meanwhile, Brazil&s;s former superstar president and one of the beneficiaries in the massive Petrobras bribery scandals, Luiz Inacio Lula da Silva, got hit with another &l;a href=&q;; target=&q;_blank&q;&g;12-plus years in prison&l;/a&g;, making that 25 years total. If he serves out his term, he will be in jail or under house arrest until he is 99 years old. Bolsonaro is close to fulfilling a campaign promise: he told his supporters that Lula would rot in prison.

If not for the market, Brazil would look like it did just a few months ago. Sad. Messy. Riddled with crime and destruction.

But if you&s;re holding Brazil equities, you&s;re up nearly 13% in dollar terms in four weeks, beating the MSCI Emerging Markets and the S&a;amp;P 500. Brazil is up 26% in the last six months, while the U.S. and the rest of the emerging markets are negative over that period.

&l;img class=&q;dam-image bloomberg size-large wp-image-43177514&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;640&q; data-width=&q;960&q;&g; Paulo Guedes, Brazil&s;s economy minister. Going up! Brazil&s;s stock market is beating the emerging market index on hopes for some serious economic reforms and an overhaul of Brazil&s;s government pension system. Photographer: Andre Coelho/Bloomberg photo credit: &a;copy; 2019 Bloomberg Finance LP

The Brazilian currency has gained 4% against the dollar. Long term interest rates are near historic lows. The market likes what it&s;s hearing from the Bolsonaro Administration.

Over the weekend, Bolsonaro&s;s economic minister, Paulo Guedes, promised Wall Street even more.

&a;ldquo;We are going towards a market-driven economy,&a;rdquo; Guedes told the &l;em&g;Financial Times&l;/em&g; in an &l;a href=&q;; target=&q;_blank&q;&g;article published Sunday.&l;/a&g; Guedes is one of the co-founders of Brazil investment bank BTG Pactual. In its heyday in the early to mid-2000s, people in the market there used to say BTG stood for Better Than Goldman. On Brazil&s;s move towards a more open market, Guedes said that &q;anyone who cannot see that is misreading Brazil.&a;rdquo;

Guedes told the FT that a pension reform plan that will save the country R$1 trillion ($350 billion) over 10 years will be approved &a;ldquo;within five months&a;rdquo;.

After that, investors will get tax reform and a privatization plan that will spare no state-owned enterprise from the auction block. (Hint: yes it will. Brazil will never be a minority shareholder in Petrobras.)

&q;I&s;m feeling like Brazil is Argentina circa 1990s under Carlos Menem,&q; says Fernando Pertini, CEO of Millenia Costa Rica, a wealth management firm. &q;You&s;ve got a strongman President who is pro-market. If (Bolsonaro) gets away with half of what (Guedes) is proposing, I believe the rally on the broader market will be huge,&q; he says. &q;Some company names will make history.&q;

Guedes is promising the market the moon. He is unlikely to deliver everything. But on some issues, like pension reform, even if the market gets an increase in retirement age that will be a market positive. Public sector workers can retire after 30 years on the job, meaning some are retiring from teaching jobs, for instance, in their early 50s.

&q;Privatizations are less important than pension reform because our deficit is so big that the economy would go bust even if you sold more state firms,&q; says Daniela Casabona, a partner with FB Wealth in Sao Paulo. &q;There is no consensus yet within the government on pension reform. No one knows how it&s;s going to look like. But any reform will be good.&q;

&l;img class=&q;dam-image bloomberg size-large wp-image-40592921&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;640&q; data-width=&q;960&q;&g; A visitor takes a photograph with a smartphone of the electronic board displaying stock activity at the Brazil stock exchange in Sao Paulo, Brazil. Photographer: Patricia Monteiro/Bloomberg photo credit: &a;copy; 2017 Bloomberg Finance LP

Last month, Bolsonaro and Guedes made the rounds at the World Economic Forum in Davos to tout the future of Brazil &q;without socialist policies&q; of the previous Workers&s; Party government led by Dilma Rousseff. She was impeached in 2016 and a caretaker government led by her vice president Michel Temer set the table for future reforms, including changes to Brazil&s;s labor union laws and a constitutional amendment to cap spending that is only really good if pension outlays are reduced.

&q;The recent election of new, pro-business leaders in the Senate and in the Lower House of Congress are important steps for this government to obtain the majorities necessary to move its reform agenda forward,&q; says Axel Christensen, chief investment strategist for Latin America &a;amp; Iberia at BlackRock. &q;It&s;s not going to be an easy task and the timeframe in which Congress moves on the issues could disappoint investors focused on the short term.&q;

&l;img class=&q;dam-image bloomberg size-large wp-image-43174514&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;640&q; data-width=&q;960&q;&g; State owned Eletrobras. Guedes would love to sell this company to the private sector. Photographer: Dado Galdieri/Bloomberg photo credit: &a;copy; 2019 Bloomberg Finance LP

Brazil&s;s bonds look priced to perfection, though the currency still seems weak at R$3.73 to the dollar. Domestically, pension law debates will keep the Brazilian real in check and be a market mover.

&q;It&s;s not our favorite country,&q; says Phillip Torres, global co-head of emerging markets for Aegon Asset Management. &q;If pension reform fails, it will be bad for Brazil&s;s economy, bad for Brazil&s;s bond market,&q; he says, adding that as investors they prefer to stay underweight because they think pension reform will be a weak, kick-the-can-down-the-road reform.

In the extreme scenario, it might not happen at all. In that case, Guedes would resign and foreigners would start to liquidate their Brazil bond positions.

&q;We&a;rsquo;ll sell to get out of the real if they don&a;rsquo;t pass pension reform soon,&q; says Torres. &q;Brazil is slightly on a precipice right now. We&s;ve heard about pension reform for many years. These guys have been dealing with this for a long time. Not sure this is the last straw as much as Guedes — and myself — would like it to be.&q;&l;/p&g;

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