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Morgan Stanley Sees Brazil Stock Gloom Despite Growth Pickup

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(Bloomberg)

(Bloomberg) -- Brazil’s economy is growing faster than expected and stocks are cheap, said Morgan Stanley strategist Nikolaj Lippmann. Just don’t expect that to translate into a rally in equities, he warned. 

Robust growth is being driven by increased fiscal spending, which is fueling inflation and pushing the central bank to raise interest rates, he said in an interview. 

“Economic growth is bad news for Brazilian equities because we know the mechanism of growth is all generated through additional debt,” Lippmann said. The higher the ratio of debt to gross domestic product, the “more oxygen you suck out of the room for investments into risk.” 

Brazil’s nominal budget deficit was a whopping 9.8% of GDP in the 12 months through August, pushing gross debt to 78.5% of GDP, up from 71.7% at the end of 2022. That jump came even as the economy expanded 3.3% in the second quarter from the year earlier, outpacing regional rivals such as Colombia, Chile, Argentina and Mexico. In September, the central bank raised its 2024 growth forecast to 3.2% from 2.3%. 

The challenging fiscal outlook and the prospect of higher rates for longer is weighing on stocks, which are lagging most major peers as investors are lured into fixed income’s double-digit returns. Markets are pricing in a benchmark interest rate of 13.25% by July next year, up from the current 10.75%.

Foreign investors, meanwhile, have withdrawn billions of dollars from local equities this year. September saw 1.6 billion reais ($286 million) in outflows, while October has already recorded almost 240 million reais in withdrawals. So far this year, foreign investors have pulled over $5.8 billion from the nation’s stock market, according to data compiled by Bloomberg. 

While the price/earnings ratio of local stocks has risen in the past two years and is currently at 9.86, that is still way below the pre-pandemic levels that typically exceeded 15.

Any gains in stocks will be limited until the central bank starts signaling an easing cycle ahead, Lippmann said. The government needs a framework to manage the fiscal outlook, while also moving toward some level of sustainability when it comes to spending, he added. 

In a September report, the strategist noted he remains overweight Brazil, with high exposure to foreign listings like Nu Holdings Ltd and MercadoLibre Inc, while remaining “light” on domestic stocks. 

“I don’t think the ship has sailed entirely, but it does require that Brazil plays along with the world and that policymakers get those rates down,” Lippmann said. “And that only happens with fiscal responsibility.”

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