Despite Rio Olympic woes, Brazil may still be a winner with investors

Youngsters gather to celebrate the arrival of the Olympic torch at Tiradentes Square in Ouro Preto, Minas Gerais, Brazil last May.

The Summer Olympic Games in Rio de Janeiro are here! For the next two-and-a-half weeks, more than 10,000 athletes representing 204 countries will compete in 28 different sports, entertaining billions of spectators across the globe. Reports of poor-quality facilities and last-minute construction travails by the host country will likely soon give way to the drama of the elite athletes competing for glory.

But for all the Games’ pomp and circumstance, academic literature is unequivocal about the costs and benefits of hosting the event. The overwhelming evidence is that, in nearly all cases, the Olympics are a money-losing proposition for host cities, even more so for those in developing countries. With a price tag of well over $10 billion, the Rio Olympics are not likely to buck the trend.

But perhaps hosting the Olympics is like having a retail store on New York’s Fifth Avenue: It may be a financial loss, but it greatly advertises the brand. With Brazil’s hosting prowess once again under scrutiny — the last time was two years ago when it hosted the FIFA World Cup — it is worth asking what sort of “brand” Brazil will show.

“We rate Brazilian equities as ‘most preferred’ relative to emerging-market peers.”

To be sure, Brazil is trying to create a new image. After more than a decade of government dominance over economic management under previous administrations, Brazil is trying a new, fiscally prudent approach under acting President Michel Temer. The fix will neither be quick nor easy. The recession, with GDP likely to contract 3.5 percent this year, makes fiscal austerity a bitter medicine. Yet taming the unsustainable national debt is just what Brazil needs to return to growth.

Temer has made fiscal rectitude the priority of his administration, but with less than two years before his term ends (though he could run for re-election in 2018), he may not get to see it cross the finish line. However, he is running a strong race, and assuming he passes the baton to a good relay, Brazil may very well end up earning a gold medal for a most-impressive fiscal turnaround.

For financial markets, the new brand of Brazilian policy has not gone unnoticed. This year the stock market is up more than 50 percent in U.S. dollar terms, and the Brazilian real over 20 percent against the greenback. We do not think the party is over. Consumer and business confidence is on the rise, and we expect the economy to emerge from recession late this year and grow about 1 percent next year. If we are correct, that would mean a 4.5-percentage point swing in GDP growth.

On the political front, the corruption investigations against public and private- sector figures, and the final verdict on the impeachment of former president Dilma Rousseff later this month, still pose unpredictable risks. But these developments speak to the independence of the country’s judiciary and the credibility of its institutions, leading to lower risk premiums.

In this context, we believe Brazilian assets offer some of the most interesting opportunities in global markets. We rate Brazilian equities as “most preferred” relative to emerging-market peers. Valuations are not stretched, and a monetary easing cycle of at least 250 basis points (2.5 percentage points) is expected to start this fall. Combining this with a broad-based economic recovery, earnings should bottom out in the second half of this year.

We also believe hard-currency sovereign and quasi-sovereign bonds will continue to perform well. The Brazilian-U.S. dollar curve is trading wider than that of its emerging-market peers, leaving room for spread compression. We also like local-currency bonds, which should benefit from the expected monetary easing cycle.

Finally, we favor the Brazilian real against the euro and the U.S. dollar. A long Brazilian real (BRL) versus short euro or U.S. dollar position looks attractive due to its double-digit percentage carry, and our USD-BRL target of 3.0 in 12 months implies an additional 8-percent return potential on the spot price.

So Brazil may not win the gold from hosting the Olympics, but Brazil may still win where investments matter.

[“source -cncb”]