Brazil just witnessed one of the most shocking election results of the year, as incumbent president Luiz Inácio Lula da Silva was re-elected by defeating right-wing candidate Flávio Bolsonaro, with a narrow 51.77% vote. And this result will likely have a massive impact on Brazil’s financial markets and stock market.
Lula’s victory confirms a scenario that investment analysts had flagged for months.
How Will Brazil’s Stock Market React?
Ahead of the vote, specialists heard on the outcome described a market that had already priced in a continuation of the liberal agenda.
In their view, the shift in expectations after the first round adjusted investor positioning for a stricter fiscal framework.
Gabriel Magno, head of investment allocation and partner at AW Capital, warned that a Lula win would undo much of that move.
“With a potential Lula victory, I believe the market will feel it, and feel it hard. All the pricing done after the first round will reverse, which will have a very strong effect on stocks, interest rates and the dollar. The market priced in fiscal improvement, lower interest rates and a country more responsible with its public accounts. With Lula, investors don’t have that confidence and would give back all of those gains,” Magno said.
And the initial market reaction shows that damage.
Higher Interest Rates, Weaker Currency
With Lula in office, the experts expect an immediate rise in futures interest rates and a weaker currency, requiring a defensive restructuring of investment portfolios.
Josias Bento, investment specialist and partner at GT Capital, projects a more cautious allocation for this scenario and stresses the need for protection outside the country.
“The best risk-return would be investments abroad. If Lula doesn’t have a fiscal plan for the coming years, the dollar could rise sharply and push inflation higher,” Bento said.
In fixed income, he notes that fixed-rate bonds could suffer if the market demands higher yields to finance the government, driving down the prices of existing securities.
Lucas Xavier, head of the equities desk and partner at AW Capital, sees fiscal pressure on government bonds as the main driver of volatility under a PT administration.
“Fixed-rate and inflation-linked bonds would inevitably lose value by their very nature, since futures rates are expected to spike in the event of a Lula victory,” Xavier said.
Dollar Earners as a Hedge
With interest rates held at elevated levels to contain inflation and mitigate sovereign credit risk, Xavier argues that stock allocation will require a focus on defensive companies with dollar revenue.