Analysis: Higher interest rates may actually boost Brazil stocks

SAO PAULO Wed Mar 20, 2013 11:19am EDT

A man walks past the new logo of Brazil's BM&FBovespa stock exchange in Sao Paulo February 18, 2011. REUTERS/Nacho Doce

A man walks past the new logo of Brazil's BM&FBovespa stock exchange in Sao Paulo February 18, 2011.

Credit: Reuters/Nacho Doce

SAO PAULO (Reuters) - With interest rates set to rise in Brazil, stocks should drop in coming months as investors flock to more lucrative bonds, right?

Don't be so sure.

A mild increase in Brazil's benchmark lending rate could actually boost shares, analysts say, by curbing inflation fears and reassuring investors who were scared off by the threat of growing government intervention in the private sector.

"It certainly wouldn't be a negative thing," said Deiwes Rubira, a partner with asset management firm Verus in Sao Paulo, who said such a move may help quell uncertainty over what many see as the government's mismanagement of the economy.

Brazil's benchmark Bovespa index has lost 7 percent this year, frustrating analysts' predictions just months ago that a fall in interest rates, currently at a record-low 7.25 percent, would boost the market by sparking a move into local equities from fixed-income assets.

That migration failed to occur, analysts said, because it was outweighed by the anxiety left over from heavy intervention in private-sector enterprises such as telecoms, electricity concessions and banks late last year.

Adding to investor concerns, consumer prices have surged in 2013, with inflation currently near the top of the government's target ceiling of 6.5 percent - a problem President Dilma Rousseff's administration has tried to slay with tax cuts, fuel price freezes - anything but higher interest rates.

"There has been an emphasis on using micro tools to address macro problems and that by definition creates distortions," said Jorge Mariscal, UBS' chief investment officer for emerging markets. "To the extent that we move away from that, I think Brazil will gradually recover its shine."

Signs suggest that may happen in coming months as the government relents on holding rates at all-time lows - long held up as one of Rousseff's major economic accomplishments.

The central bank dropped references to "low rates for a prolonged period" from its recent policy statements, and Rousseff has repeatedly pledged that inflation will remain under control.

NOT ALL SECTORS WILL BENEFIT

A recent central bank poll of economists showed interest rates are expected to rise 100 basis points to 8.25 percent this year, starting as early as May.

A separate Reuters poll, released on Tuesday, showed the Bovespa was expected to rise around 18 percent to 67,500 points by the end of 2013. <EPOLL/BR>

The expectation may seem counterintuitive considering stocks are usually expected to fall when interest rates rise. Normally, fixed-income investments become more attractive than equities and expected corporate earnings decline when measured at present value. But the Bovespa may be a special case.

"Investors could see this as a sign that the government is taking a more orthodox and thus more predictable path," said Alexandre Gartner, head of equity research at HSBC in Brazil.

Gartner said investors could turn less bearish on local equities in such a scenario, adding momentum to a rise in Brazilian stocks.

The positive outlook was shared by JPMorgan Securities analysts, who raised their recommendation on Brazilian equities to "neutral" in an investor note earlier this month, saying "the recent improvement in policy environment could drive a rapid covering of short positions.

That's not to say every type of stock will benefit, though. Gilberto Nagai, head of Brazilian equities at Itau Asset Management in Sao Paulo, said the negative impact of a rate increase on some sectors such as real estate could offset any improvement in confidence.

However, analysts say other companies would certainly benefit from an increase in lending rates. Chief among them are private-sector banks such as Banco Bradesco (BBDC4.SA) and Banco Santander Brasil (SANB11.SA).

Last year President Rousseff publicly shamed the banks for not cutting their lending rates fast enough to match the benchmark interest rate's declines, while directing state-controlled banks to lower interest rates on loans.

Analysts cited more favorable conditions for banks under a higher interest rate scenario, in which they would gain more from holdings of interest-rate-linked government debt and face decreasing government pressure to reduce lending spreads.

"Things changed for the better," Credit Suisse analyst Marcelo Telles wrote in an investor note this week, as he upgraded Itau Unibanco (ITUB4.SA), Brazil's largest non-government bank, to 'outperform.'

(Editing by Brian Winter and W Simon)