Brazil: Worth a Closer Look

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by Franklin Templeton Emerging Markets Equity 

Key Takeaways

• • The Russia-Ukraine conflict has weighed on global equity markets, with the exception of Brazil.
  • Surging commodity prices benefit Brazil, the fourth-biggest commodity exporter globally.
  • Ample renewable energy resources could shield Brazilian farmers from higher energy and fertilizer costs.

Brazilian Equities Rally on Higher Commodity Prices

Brazil defied the global market rout in February to end the month higher. The MSCI Brazil Index rose 18% in the first two months of the year, outperforming the MSCI Emerging Markets (EM) Index and the MSCI US Index.¹ The increase in energy, industrial and agriculture commodities prices this year is benefiting the MSCI Brazil index, which has a 45% weighting in these sectors. Easing concerns over the outcome of the presidential election in October have reduced the risks for the market in the eyes of investors.

While the impact of geopolitical tensions remains difficult to predict for now, Brazil stands out to us as one of the potential beneficiaries of sanctions against Russia.

The World’s Fourth-Largest Commodity Exporter

Brazil is the world’s fourth-largest commodity exporter. It is the biggest exporter of soybeans and coffee, and the second-biggest exporter of corn and iron ore.² The continuation of last year’s commodity price surge amid global supply concerns from the Russia-Ukraine conflict is potentially good news for Brazil’s commodity exports, economy and market.

Agricultural commodity prices surged 18% in the first two months of the year, driven by geopolitical uncertainty, adding to their 25% gain in 2021.³ We expect this rally to be a tailwind for Brazil given its status as a commodity exporter.

Brazil, like many other agricultural exporters, could face higher fertilizer prices and energy costs due to the Russia-Ukraine conflict. Russia and Belarus are the second- and third-largest potash producers globally, with the latter’s potash exports already sanctioned. Potash is a key agricultural fertilizer.

However, Brazil may have a competitive edge over other agricultural exporters. The country generates 80% of electricity through renewable sources, shielding it from higher prices for carbon-intensive electricity production. In addition, its ample domestic supply of animal feed could prove advantageous amid rising global energy and soybean prices.⁴

China and the United States are Brazil’s largest export partners. The two countries account for 28% and 13% of Brazil’s total exports respectively, while Russia’s share is under 1%.⁵

Earnings and Valuation Support

The energy, materials and agricultural sectors account for 45% of the MSCI Brazil Index. Surging commodity prices are leading analysts to raise earnings forecasts in Brazil. The consensus estimate for 12-month forward earnings per share in Brazil is up 6% year-to-date.⁶

Despite the stock market’s recent climb, valuations look appealing. The MSCI Brazil Index’s price-to-earnings ratio of 8x on a 12-month forward basis remains at a discount to its 15-year average of 11x.⁷

Potential Risks

• • • The US Federal Reserve has signaled its intention to tighten monetary policy amid rising inflation.
    • A decline in commodity prices could weaken the investment case for Brazil.
    • The lead-up to the country’s presidential election in October is likely to come with political noise.

In these uncertain times, we think that Brazil, with its abundant supply of commodities, favorable corporate earnings momentum, and undemanding equity valuations, deserves greater attention from investors.

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.

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1. Source: Bloomberg, as of March 1, 2022. The MSCI Emerging Markets Index captures large- and mid-cap representation across 25 emerging-market countries. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. MSCI makes no warranties and shall have no liability with respect to any MSCI data reproduced herein. No further redistribution or use is permitted. This report is not prepared or endorsed by MSCI. Important data provider notices and terms available at www.franklintempletondatasources.com.

2. Source: CIA World Factbook 2020.

3.Source: S&P GSCI Agriculture Index.

4. Source: Government of Brazil, “Renewable energy sources represent 83% of the Brazilian electricity matrix,” January 28, 2020.

5. Source: World Integrated Trade Solution, latest available data as of 2019.

6. Source: Bloomberg, as of March 1, 2022.

7. Source: Bloomberg, as of March 1, 2022.