Brazilian stock market among world’s best in May due to commodities super-cycle: will it last?

RIO DE JANEIRO, BRAZIL – The Ibovespa, B3’s main stock index, was a negative highlight since the start of the pandemic, having “boasted” the mark of the worst overall performer among market benchmarks. In 2021, and due to the commodities rally in April and May, this has changed. The index bounced back to near-record highs of 125,000 points, reaching 123,000 points last Tuesday, May 18.

As pointed out by Fernando Ferreira, chief strategist of XP, the Ibovespa not only experienced one of the highest climbs in the world last month, ranking 7th in the period in dollars, with a high of 8.12% until closing the day before, as it no longer appears in the top 10 of the worst declines of the year.

On February 26, the situation was completely different. Ibovespa hit its yearly minimum, reaching an accumulated drop of 7.55% in 2021, at 110,035 points. At the time, the index was established as the worst in the world.

According to Ferreira, this improvement is due to the commodities boom and the fact that Brazil is one of the countries with the most exposure to these products in the Stock Exchange. “Around 33% of Ibovespa is made up of stocks linked to commodities, while other indexes have a much lower exposure to the sector,” he explains.

It is worthy of note that iron ore, the main product exported by Vale (VALE3), has appreciated over 30% this year, hitting more than US$200 a ton for the first time in history on May 7, which boosted the mining company’s shares, accumulating gains of 42.33% in 2021 and 4.59% this month. Vale’s shares account for 12.3% of the composition of the Ibovespa’s theoretical portfolio.

Other commodities such as oil also posted considerable gains in the year. In 2021, a barrel of Brent crude has soared 34.43%, reaching US$69.42. Nevertheless, the shares of Petrobras (PETR3; PETR4) are still trading in the red for the year, since the uncertainties regarding political intervention in prices have been hanging over the state-owned company since February 22.

However, the oil company’s shares have increased by 11.47% this month. Petrobras’ shares represent 9.63% of Ibovespa.

Marcos Kawakami, equity fund manager at BNP Paribas Asset Management, believes that with global economic activity picking up with the push of fiscal stimulus measures and infrastructure development plans, which require extensive use of raw materials, it is normal for commodities to appreciate due to increased demand.

“We do not see a large increase in the supply of commodities in the short term either, so this appreciation trend should continue,” says Kawakami.

In addition, according to Ferreira, as the market is concerned about the rise in inflation in the United States and investors worldwide are looking to hedge against this phenomenon, Brazil is ultimately a very well-positioned country in this scenario because it is firmly tied to the rise in commodity prices, which are currently pressuring inflation indicators in the U.S.

This opinion is shared by Levante’s analysis team, for whom the sharp appreciation of commodities should be slow to pass. “Despite some fears regarding inflation, the U.S. and European central banks should maintain “stimulative” monetary conditions. And in times of abundant money and zero or negative interest rates, one of the alternatives for investors worldwide is to buy commodities to defend themselves from the loss of currency value.”

The strategist also recalls that the Brazilian stock market was heavily discounted due to political issues and macroeconomic risks such as the upward trajectory of the debt to gross domestic product (GDP) ratio.

“We were so cheap and so far behind that we ended up experiencing a convergence of beneficial factors: we are now in the best possible place to leverage a market that seeks to protect itself from inflation,” he assesses.

Finally, Kawakami recalls that the banks’ solid results in the first quarter also had their share of responsibility in the stock market’s positive moment. Itaú Unibanco (ITUB4) rose 5.2% in May, while Bradesco (BBDC3; BBDC4) and Banco do Brasil (BBAS3) increased 5.4% and 8.3%, respectively.

Although the ROE (Return on Equity) of financial institutions has dropped because of increased competition and the Central Bank’s measures to encourage the growth of fintechs, Marcel Campos, banking industry analyst at XP, says that companies are still very attached to large banks, mainly because of credit and the need for a more focused service, which covers more complex needs, while fintechs focus more on individuals.

Expecting further hikes

Recently, XP revised its projection for the Ibovespa for the end of 2021 from 135,000 to 145,000 points, stressing as its two main reasons the strong increase in profit projections of Ibovespa companies and a slight accommodation in long-term interest rates in Brazil (real interest rates).

Earnings per share in Brazil are expected to grow by 199% in 2021 compared to last year. Even when compared to 2019, 2021 should post sharp growth of 125%. However, for 2022, the market is projecting stable earnings compared to 2021, most likely due to the projection of a weaker dollar against the Brazilian real and commodity prices normalizing at lower levels.

Bradesco BBI’s analysis team also revised its projections for the Ibovespa, raising its expectation for the index price at the end of the year from 130,000 to 135,000 points. For 2022, Bradesco readjusted its estimates on the benchmark from 140,000 to 150,000 points.

“We perceive Brazilian equities as a case of gradual compression and assume that the risk premium will gradually drop in 2021 and will experience a more expressive drop after the 2022 elections, considering a reduction in the country’s fiscal and political risk,” write analysts André Carvalho and Fernando Cardoso.

In their opinion, the profits of companies that are part of Ibovespa should be higher than expected in December 2020, something they consider to have been driven by the increase in commodity prices, but not only that.

“Comparing Bradesco’s projections with the consensus figures, we are more optimistic than the market average in information technology, healthcare sector and general industries,” argues the bank’s team.

For its part, BNP Paribas is optimistic about the recovery of the Brazilian economy, but there is no guarantee of an upward trend for the stock market in the long term. “We are optimistic about the vaccination scenario, the government signed an agreement with Pfizer and Brazil is currently vaccinating around 800,000 people a day, which is our acceptable scenario for the immunization rate,” he explains.

In the bank manager’s opinion, as a greater number of Brazilians is vaccinated, ICU bed occupancy in hospitals should drop and so should the pressure for stricter social isolation measures.

Consequently, Kawakami believes that company revenues will grow, since this is a “consumption suppression” crisis, not a credit problem or a long-term loss of income for families and companies.

However, he cautions that the rise of stocks in this scenario will be uneven, with some companies and sectors doing better, as occurred between 2010 and 2016, when some companies saw massive increases in share values, while others plummeted.

For now, the outlook for commodity companies remains positive.

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