While described by many as a highly divisive vote, the election of right-wing populist Jair Bolsonaro as Brazilian president has been broadly welcomed by markets.
Bolsonaro’s victory had been widely expected for several weeks, with the Social Liberal Party leader managing to secure 55.2 per cent of the vote after seeing off left-wing rival Fernando Haddad, who garnered 44.8 per cent.
Haddad was the successor to former president Lula de Silva and represented a different economic approach to Bolsonaro’s more free market leanings.
However, the election of Bolsonaro has come against a backdrop of increased frustration with corruption and low economic growth, with Brazil lagging its emerging market counterparts.
The Brazilian economy is forecast to grow by just 1.4 per cent in 2018 compared with 4.7 per cent for emerging market and developing economies more broadly, according to the International Monetary Fund.
“Although a socially divisive figure, Jair Bolsonaro has convinced the market that he is Brazil’s best economic option,” said Delphine Arrighi, manager of the $191.4m Merian Emerging Market Debt fund.
“The Brazilian real has returned close to 15 per cent since its mid-September trough, bucking a generally sluggish trend across emerging market currencies.”
Performance of emerging market currencies vs US dollar YTD
Source: FE Analytics
Much of the positive market sentiment surrounding Bolsonaro’s election victory is linked to potential reform of the pension system, a pro-growth stance and his choice of finance minister: Paulo Guedes, a well-respected economist.
“In particular, his pension reform plans go beyond the bill currently sitting in the lower house and would, if successful, be a game-changer for Brazil’s long-term debt sustainability,” said Arrighi. “The privatisation of a substantial number of Brazil’s state-owned enterprises would also receive a warm welcome from the market.”
Despite lower economic growth, Brazilian stocks have performed strongly this year – outperforming at a time when other emerging markets have largely struggled.
Although it has seen considerably higher volatility of 27.46 per cent, the MSCI Brazil index has significantly outperformed the broad emerging market peer group and the global equity benchmark in 2018, as the chart below shows.
The MSCI Brazil index is up by 7.71 per cent – in sterling terms – while the MSCI Emerging Markets has lost 12.59 per cent (with volatility of 14.41 per cent) and the MSCI AC World has lost 0.64 per cent (with volatility of 12.99 per cent).
Performance of indices YTD
Source: FE Trustnet
As the likelihood of Bolsanaro’s victory strengthened in the past few weeks, so did the performance of the Brazilian index, rising by 26.2 per cent – in sterling terms – since the end of August.
Indeed, fund managers believe that the election could be supportive of Brazilian assets, given some of the comments made by the president-elect during the campaign.
Kim Catechis, co-manager of the five FE Crown-rated Legg Mason IF Martin Currie Emerging Markets fund and head of global emerging markets at Martin Currie, forecasted a “sharp recovery” in Brazilian assets, including equities, bonds and the Brazilian real.
Meanwhile, Pablo Riveroll, head of Latin American equities at Schroders and manager of the $246.9m Schroder ISF Latin American fund, said the asset manager remains cautiously positive on Brazilian equities.
“The market is trading at attractive valuations, with a forward price-to-earnings [P/E] ratio of around 10x, which is a discount to wider emerging markets and to its history, with above average earnings growth,” he said.
“We aim to take advantage of market volatility to add to high quality Brazilian companies at discounted valuations if our base case scenario plays out.”
However, the new president will face a number of challenges, the managers warned.
“Bolsonaro’s recent efforts to broaden his support base by inviting representatives of the Democrats party into his administration should be seen as a sign of pragmatism,” said Merian’s Arrighi.
“Of course, strong measures have proven difficult to pass in Brazil in the past. The market will focus intently on the new government’s ability to form a coalition for reform despite a notoriously fragmented congress.”
Martin Currie’s Catechis said Bolsonaro may face strong opposition to gathering support for his proposed reforms, given their radical nature. 
“In an already polarised country, unions will challenge reforms and privatisation, while any anti-corruption drive will result in a period of policy stagnation, as bureaucrats will hesitate to sign off in case they end up in jail,” he explained.
As such, Schroders manager Riveroll said performance of Brazilian assets will likely depend on the extent to which the Bolsonaro administration delivers its policy measures.
“We believe that pension reform is likely to be approved by the new government,” he said. “The market may be vulnerable if it does not commit to presenting and passing pension reform at the beginning of its administration.”
Capital Economics chief emerging markets economist William Jackson said there will be three things to watch out for under Bolsonaro’s presidency.
The first move many will be looking out for is whether the president-elect decides to change the governor of the Brazilian central bank, as the past three presidents have done so.
“The latest rumours are that Bolsonaro will ask current governor Ilan Goldfajn to stay in his role,” said Jackson. “A quick announcement to this effect would be positive for markets, both because Goldfajn has earned a reputation for orthodox policymaking, but also because it would diminish fears of exchange rate-targeting and might hint that Bolsonaro wants to de-politicise the central bank.”
The second will be whether the new president decides to continue the federal intervention in Rio de Janeiro state that expires at the end of the year and declared by current president Michel Temer in response to a deteriorating security situation.
“While this is in place, constitutional amendments – which are needed to tackle many of Brazil’s fiscal problems – are prohibited,” said the economist. “If Bolsonaro allows this federal intervention to expire, it would be a sign that he may be clearing hurdles to economic reform.”
It would, however, be politically challenging for Bolsonaro, according to Jackson, given his strong emphasis on law and order during the election campaign.
Lastly, Brazil watchers will be closely following the budgetary process, which should give hints of his fiscal ambitions by April, according to Jackson. While the president-elect has limited capacity to change the 2019 budget, there are rumours the current congress – which sits until 22 December – will reduce spending plans.