Charles Schwab: Brazil Stocks Are Cheap, But Hard to Spy Catalyst for Recovery

SAO PAULO–Brazilian equities are cheap compared to other markets around the world after the country's stock market posted one of the worst performances anywhere in 2013. Yet that doesn't necessarily mean it's time to buy.

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"The problem is cheap is great, but there just doesn't appear to be a catalyst for a rebound in the market," says Michelle Gibley Director of International Research at Charles Schwab(SCHW).

Ms. Gibley says she's been pessimistic on Brazil for quite some time, as the country is caught in a negative growth spiral. High inflation means the central bank has to raise interest rates, which will slow growth further. A weakening currency and strong public spending compound the problems.

The country's infrastructure hasn't kept pace with recent economic growth and acts as a major bottleneck, driving up the cost of getting products to markets. Unemployment is low, but so is productivity.

Moreover, as China's economy slows, demand for Brazil's commodities declines. Consumers have so far propped up the economy but economists believe they aren't going to be able to continue to spend at the pace seen in recent months and years. Retail sales fell unexpectedly in January.

The government doesn't seem to be interested in tackling the major reforms that Ms. Gibley believes are necessary for an equities rally. The main Ibovespa on the BM&FBovespa SA exchange in São Paulo fell 15.5% in 2013, the worst-performing index among the world’s 20 largest economies.

“What we really need is an overhaul of the economy in terms of some major reforms and there doesn't seem to be a political will for that now particularly ahead of the elections,” says Ms. Gibley. “So for the stock market the bottoming out might have further to go.”

President Dilma Rousseff is expected to seek reelection in October, and a new poll published on Tuesday indicates she has a comfortable lead over her main opponents.

The elections aren’t likely to throw up any surprises in terms of policy, says Ms. Gibley. Politicians may have to react if there is a return to the massive street protests seen in June and July last year, she said.

Millions of Brazilians poured onto the streets of towns and cities across the country last June and July to protest a whole host of issues, from rising public transportation fares to perceived corruption and poor public services. Protests often turned into violent confrontations with police. The number and size of protests have dwindled, however, while the level of violence has increased.

"The interests of investors and the electorate are usually not the same," says Ms. Gibley. "What investors want are reforms that probably hurt the electorate in the short term but provide a better long-term future."

Before the elections, Brazil will host the 2014 soccer World Cup, in which 32 teams will compete in the world's most-watched sports tournament. Millions of people are expected to visit Brazil during the month-long event, which runs from mid-June to mid-July.

Despite any short-term boost to the economy, there may be a longer-term hangover that could again act as a drag, says Ms. Gibley.

“Typically there's an overhang because you have to pay for the debt that was raised to fund all the infrastructure to host the events,” she says. “That just slows growth further.”