Record flows into Brazilian stocks begin to ebb ahead of elections

Higher commodity prices and a stronger currency offset political uncertainty in Brazil during the first quarter of 2022, as foreign investors flocked to the B3 SA - Brasil Bolsa Balcão stock market and drove returns into double digits.

Non-Brazilian investors, who typically account for about half of the stock market volume, poured $68.4 billion reais into the domestic stock exchange in the first quarter. The period saw little follow-on or initial public offering activity, with foreign investors doing most of their trading through the secondary market.

Latin American markets, and Brazil's in particular, have fared better than expected from the war in Ukraine than other markets around the world. A repricing of commodity exports together with a sharp outflow from countries close to the war in Europe all contributed to stronger returns in regional markets.

Net inflows from foreign investors during the first quarter were far higher than those made in the entire period from 2016 through 2019, data from the stock market operator shows. 2021 and 2020 comparison data is still under review.

The Brazilian stock index produced 10.8% dollar returns through mid-April, data collected by S&P Global Market Intelligence shows, recovering lost ground during the first two years of the pandemic. Double-digit returns come as opposed to a negative 7.8% return in the S&P 500 index, and an even bleaker performance in other emerging markets, which fell by 8.6%.

The rise in commodity prices came as a boost to a financial market that was already showing signs of recovery in early 2022.

"We started the year with quite a weak Brazilian real and the stock market at relatively low levels," Luciano Rostagno, Latin American chief strategist at Mizuho Bank, said in an interview. "Positive momentum for the Brazilian stock market was aided further by the conflict in Ukraine."

As war broke out in Europe, many emerging market investors divested from large economies such as Russia or China and placed their funding elsewhere. In that sense, Brazil and Latin America looked more attractive as parking spots for EM investors given the region's distance from the conflict.

Financial and currency markets in most Latin American countries posted strong gains during the first quarter of the year. The Brazilian real saw appreciations of about 15.6% in the period through mid-April.

According to Eduardo Camara Lopes, chief investment officer with Itau Asset Management S/A, the Brazilian stock market benefits as well from a global sector trade. Even prior to the war, global investors had begun moving away from tech companies, which have seen huge inflows in the previous years, and into so-called value stocks.

The Brazilian index is full of the latter.

Institutions like Itaú Unibanco Holding SA, Banco Bradesco SA, B3 and Banco BTG Pactual SA have a significant weight in the domestic stock index Bovespa, all of them booking strong stock returns during the first quarter. "Brazil has a strong exposure to both commodities and banks," Fernando Ferreira, chief strategist with XP Inc., wrote in a report.

"There is a huge inflow going on in Brazil, but it is mostly into three sectors: materials, energy and financials," Itaú's Camara Lopes said. "Globally, all of these sectors are performing well and attracting capital."

The path ahead

But despite these tailwinds, experts forecast net inflows will lose steam in the coming months. A faster tightening of monetary policy in the U.S. will likely affect the appeal of emerging markets, while Brazil's presidential elections in October could temporarily discourage further investing.

Preliminary data from B3 already shows a minor net outflow in April of 1.43 billion reais, as the country draws nearer to what is expected to be a highly polarized election. A contest likely to be held between current president Jair Bolsonaro and former leftist president Lula Da Silva is generating uncertainty as to the future of the country's economic policy.

"I don't expect this trend to continue," Rostagno said. "Foreign investors will eventually become cautious on Brazilian assets."

As of yet, support for Brazilian risk assets has been mostly driven by foreigners, as opposed to local investors who have mostly shied away from stocks. A higher monetary rate is pushing some Brazilians back to fixed-income products, which now produce a return of more than 1% per month.

Mizuho's Rostagno argues that it is unlikely that local investors will sustain current levels should foreigners reverse course.

"The conflict in Ukraine has made Latin America assets more attractive in relative terms," he said. "But fundamentals have not changed. Money that came to the region is essentially more of a short-term nature. Thus, we could see a reversal any time."

As of April 26, US$1 was equivalent to 4.97 Brazilian reais.