A Top Brazilian Fund Manager Says Despite the Selloff the Country Could Still Be ‘Best Positioned for the 21st Century’

Artur Wichmann, CIO of XP Inc.

The surprising outcome of Brazil’s presidential elections has put the country’s equities through the wringer.

The Ibovespa, Brazil’s benchmark index, plummeted 14% on Monday, marking its largest percent decrease since March 2020, while the iShares MSCI Brazil ETF (EWZ) dropped 20%. The move erased most of the indexes’ year to date gains, including the surge that followed Brazil’s first-round election results earlier this month, which suggested Sen. Flávio Bolsonaro had the advantage over incumbent President Luiz Inácio Lula da Silva.

Brazil’s financial sector was especially hard hit. Shares of XP, an investment management company and one of Brazil’s largest brokerages, had its worst day on record Monday, plummeting near 50%.

Barron’s spoke with Artur Wichmann, XP’s chief investment officer, about how investors should interpret the election results, and his outlook for Latin America’s biggest economy.

This conversation has been edited. Some parts of the interview were previously published in the Barron’s Global Signals newsletter.

Barron’s**: How are you thinking about how the market reacted in the wake of the Brazilian election results?**

Artur Wichmann: Brazil is perceived to have one very large macroeconomic Achilles’ heel, which is the fiscal situation. We have a combination of three characteristics that together are very toxic: A very elevated debt-to-GDP [ratio] for an emerging market country, a very large fiscal deficit, and a budget that is very rigid [and] constitutionally fixed, which means that it’s very difficult to make fiscal policy in Brazil.

If you put those three things together, we have a debt-to-GDP ratio which is on an explosive trajectory. That was what mattered for the markets in this election. We need a president that addresses the fiscal situation. The market knows President Lula, knows he has made some attempts, but Brazil is still in a bad fiscal situation under his mandate. So the market says, this other guy [Bolsonaro] is talking about it. There wasn’t a very clear plan, but there were talks of balancing the budgets. So the market votes for fiscal stability.

There are gigantic risk premiums associated with Brazilian assets because of our fiscal vulnerability. So the market says, if there is a possibility of a change in direction for the better in fiscal policy, I’m going to compress risk premiums. And that’s exactly what happened the Monday after the first round of presidential elections.

Then Lula won the second round, which was a huge surprise to the market. The market says, we know the fiscal policy under President Lula and we don’t like it. So we have to reassign risk premiums to the Brazilian assets, which had been removed because of the assumption that there was going to be a change in the fiscal policy.

Do you think that the market is fairly priced where it is now? When you think about equities, is it still a market that foreign investors should be considering despite the fiscal problem and despite the election result?

Absolutely, if there’s one thing you cannot bring through the investment process is any sort of prejudice. You have to judge every asset or every investment opportunity with the basis in its fundamentals.

The opportunities in Brazil are here, but we have to have a consistent fiscal policy. [Lula’s] attitude toward fiscal policy has been ambiguous. He hasn’t dismissed fiscal concerns as not being relevant. But sometimes he says some things that make the market a little less confident. I think President Lula is a very pragmatic man. He’s intelligent. No president wants to face a fiscal crisis right from the get-go. So I think we will have a fiscal policy that is consistent—to a certain extent. But my certainty as far as that isn’t great, because there is discord in congress, even within the government’s party. You have people that say we have to take care of the fiscal, and others that say it’s all orthodox economics, or us bowing to the financial markets.

The political system could take a clue from what the voters said and get a compromise to make fiscal policy that is sustainable. That guarantees the risk premiums converge over time to levels more normal, and then Brazil can become a star. I’m not making that projection, yet.

What I want to convey is that the realm of probabilities in Brazil is very wide. Brazil could be one of the countries that is best positioned for the 21st century. We have cheap renewable energy, which could feed data centers. We have rare earths which could feed semiconductors. We have food, we have arable land. It’s the equivalent of a car that’s got an extremely good engine and good suspension. But if you don’t put in the right tires, then it’s all for nothing. So this is a very powerful position—if you use the correct macroeconomic frame.

How does ongoing ambiguity about the path of Lula’s fiscal plans factor into the central bank’s decision to keep lowering rates?

If the government does the right thing, the central bank could continue to lower interest rates. Interest rates in Brazil, real interest rates in Brazil are extremely high. They are among the highest in the world. And a lot of that is risk premium because people are afraid of [the] unanchoring of inflation expectations, and people are afraid of the currency depreciating a lot.

So for investors, is it about seeing who is well positioned despite the macro challenges?

Yes and no. Brazil’s got two big problems, one macro and one micro. The micro is: Brazil is one of the most difficult business environments in the world. To set up a simple bakery in Brazil is an extremely complex process. There was a time that there was a new tax arrangement in Brazil a day. Every single day, the IRS, the environmental agents that were changing the taxation on a daily basis. Imagine how difficult it is just to be on top of that.

So the microeconomic agenda makes that potential that I just told you very difficult to realize. But it’s possible. You can look at it, glass half empty, glass half full. If we fix it, Brazil could fly, as did South Korea. But we haven’t addressed it in decades, right? Are we going to do it now? I’ll tell you in a couple of months.

Write to Sabrina Escobar at sabrina.escobar@barrons.com. Follow her on X and subscribe to her newsletter.

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