Stock investors cautiously tiptoe back into Brazil

SAO PAULO/RIO DE JANEIRO Fri Oct 18, 2013 12:18pm EDT

SAO PAULO/RIO DE JANEIRO Oct 18 (Reuters) - After betting for most of the year that Brazilian stocks would continue to tank, some investors are now cautiously looking for opportunities to buy into a market that might have just become cheap enough.

But calls to deploy money into Brazilian shares still lack conviction. For now, analysts are recommending that investors hunt for bargains or cherry-pick shares in companies that could benefit from an expected rebound in emerging markets.

Investors have reasons to be skeptical about Brazil, a market whose performance this year has trailed that of some developed nations still grappling with the impact of the 2008 financial crisis. Mounting state meddling in the economy, signs that the country's growth model is fatigued and political uncertainty have kept many investors on the sidelines.

Brazil's benchmark Bovespa stock index currently trades near 56,000 points, more than 20 percent off the 73,000 points it reached in September 2010. The index is down almost 10 percent for the year despite a sizzling 25 percent rally since July that took it into bull market territory.

"Some price signs are encouraging, but you don't feel that conviction has yet taken hold with market participants," said Paulo Bylik, who oversees 9.5 billion reais ($4.4 billion) in assets for Rio Bravo Investimentos in São Paulo. "We are far from a consensus on Brazil being a 'buy now' call."

Foreign investors have poured over $11 billion into the São Paulo Stock Exchange since the start of the year, and the nature of those inflows shows a tentative improvement in market sentiment toward Brazil.

During the first six months, investors built massive short-selling positions, betting that stock prices would fall further. Now, data from bourse BM&FBovespa SA shows that foreigners are becoming more optimistic about market prospects in Brazil, with long positions on index futures outweighing short positions by a slight margin.

Still, according to Credit Suisse Securities, recent inflows have gone mostly to exchange-traded funds - a strategy usually used by institutional investors willing to increase exposure to the country without strong bets on any particular stock.

LITTLE CONVICTION

Bylik forecast that long-term-oriented investors such as countercyclical endowments are likely to jump in as more attractive entry points arise. "But there is still an issue with confidence across the board," he noted.

So far, few investors have been making a positive case for Brazil, even though most of them currently have above-average holdings of Brazilian assets, according to HSBC Securities strategist Ben Laidler.

"Brazil is now a consensus overweight on a low conviction, focused on domestic stocks, but mainly driven by underweight calls in other emerging markets such as China, Taiwan and South Korea," Laidler said.

Yet, market conviction is improving, said Marcos Paolozzi, who helps manage 6.5 billion reais in assets for Fator Administradora de Recursos in São Paulo. He cites recent policy statements that are bolstering credibility and a stabilization in earnings estimates trends as "the catalysts that investors needed to see before placing bets again on Brazil."

For some foreign investors, returning to Brazil took time because the losses of recent years caught them off guard, Paolozzi added. Yet some of them recognize the enormous upside potential the market has, he said.

'EVERYTHING HAS A PRICE'

JPMorgan Securities strategists calculate that Brazil shares are now trading at 11.1 times 12-month earnings estimates, below the 11.7 times for global emerging markets. For 2014, JPMorgan sees Brazil's price-to-earnings ratio at 10.8 times estimated earnings, compared with 14.5 times for the United States and 10.5 times for global emerging markets.

"Brazil remains fairly unattractive, unless the world economy picks up and commodity prices go up again," said Johan Kahm, who oversees $200 million in emerging and frontier markets at FMG Funds. "But everything has a price. If you buy Brazilian shares at 5 times earnings, that's attractive."

That investors are basing their decisions to enter Brazil on prices is a stark contrast to the must-have status the country enjoyed at the onset of the 2008 crisis. At that time, investors would be comfortable buying stocks trading above 20 times earnings, Kahm recalled.

After 2010, when the economy expanded at the fastest pace in 24 years, Latin America's largest country failed to live up to expectations. Since 2011, growth has averaged about 2 percent annually and erratic policy decisions have hampered confidence, leading strategists to rate Brazil's equity market a "sell."

Trends in the Bovespa and episodes such as the downfall of tycoon Eike Batista's Grupo EBX provide a good measure of the country's fall from grace - and its tentative stabilization.

OGX Petróleo e Gas Participações SA, once EBX's flagship company, has shed 93 percent of its value in the past year on concerns it may go bankrupt due to delayed output and mounting debt. The slump in OGX, apart from weighing down foreign and local investor confidence in Brazil, dragged down the Bovespa because of the stock's heavy weighting in the index.

BM&FBovespa recently rushed to enact changes in the way the Bovespa is calculated - the first broad changes in the index's 45 years of existence. The changes, which will take effect in May, are aimed at preventing problems such as OGX's woes from affecting the market as a whole.

Much of the Bovespa's recent rally could also be attributed to a delay in the expected unwinding of U.S. stimulus measures, which for years have supported global appetite for risk. Bets that the U.S. Federal Reserve may postpone a tapering of its bond buying program, if proven correct, would most likely boost emerging markets in general, Brazil included.

"A number of market situations - the Federal Reserve's taper-off, or the impact of the woes facing tycoon Eike Batista's group - offer some decent entry points," Bylik said.

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