Brazil's Stock Market is Heating Up at Just the Right Time

With risk mounting in other places around the world, Brazil's stock market is heating up at just the right time. The country's benchmark Bovespa Index has risen for four straight days since hitting its cheapest level since May last week.

What's more is that Brazil's stocks are poised to surge even further as its economy storms back from recession and investment firms rush to cash in on the country's upside.

"The investment environment is probably the best in 20 years," Geoffrey David Cleaver, who manages a $500 million private equity infrastructure fund at the Sao Paulo unit of Banco Santander SA (NYSE ADR: STD), said last week at an event in New York.

Indeed, low interest rates and government stimulus measures have conspired to invigorate Brazil's economy. Brazil was one of the last countries to actually fall into recession and one of the first to dig its way out. Its gross domestic product (GDP) declined by just 0.3% last year.

This year the economy will expand by 5.8%, according to central bank estimates, driving both Brazil's currency and stocks sharply higher.

The Bovespa surged 83% last year, its best performance since 2003, while the real leapt 33% in 2009, making it the best performer among emerging market currencies. And despite a mild correction in the first few months of this year, Brazil's economy is poised to make similar strides in 2010.

That's because lower valuations and turbulence in other parts of the world - debt in Europe and the United States and a potential real estate bubble in China - are luring investors back.

"Despite recent concerns on sovereign risk in Europe and monetary tightening in China, we believe global economic recovery is well on track and still see stronger-than-expected GDP growth globally" for the first half, Credits Suisse Group AG (NYSE ADR: CS) said in a note to clients. "This, coupled with strong earnings growth in 2010 and not yet expensive valuations, should drive equity markets in Latin America higher."

Certainly, a strong fourth-quarter earnings season added to the bullish sentiment surrounding Brazil. Brazilian companies posted fourth-quarter earnings that were an average 2% higher than Credit Suisse's predictions.

"These recurring earnings surprises could result in upward revisions in earnings, which should contribute to market appreciation," the bank said.

Now, many investment firms are looking to capitalize. Buyout firms are poised to shell out $9 billion for stakes in Brazilian companies, Bloomberg recently reported citing statistics from the nation's private equity and venture capital association.

Grupo Santander Brasil and San Francisco-based Paul Capital Partners said they might purchase stakes in companies that will benefit from the country hosting the World Cup in 2014 and Olympics in 2016, according to the report.

Foreign direct investment will jump 74% this year to $45 billion, matching the record in 2008, as the country builds houses, subways, railroads, roads, hotels and stadiums for the soccer and Olympic games, the central bank has said.

A similar buildup took place in and around Beijing before it hosted the 2008 Summer Olympics.

The Carlyle Group, the world's second-largest private equity firm, plans to invest $1.2 billion in Brazil in five years, while the Axxon Group in Rio de Janeiro said it is considering firms that supply the oil, health care and media industries.

Buyout funds in Brazil raised at least $10 billion by the end of 2008, but only 10% of that was spent last year, ABVCAP President Luiz Eugenio Figueiredo told Bloomberg in an interview.

"We have plenty of dry powder in venture capital and private equity," said Figueiredo, who is also chief operating officer of Sao Paulo-based Rio Bravo Investimentos.

JPMorgan Chase & Co. (NYSE: JPM) is reportedly interested in buying a minority stake in private equity firm Gavea Investimentos Ltd. The bank earlier this week announced the launch of a new investment trust that focuses exclusively on Brazil's domestic market. It would be just the second such investment trust, behind Blackrock Latin America, specifically designed to capitalize on that region.

Brazil has traditionally been viewed as a resource play, with iron ore heavyweight Vale (NYSE ADR: VALE) and oil giant Petroleo de Brasileiro SA (NYSE ADR: PBR) making up 40% of the Bovespa Index. However, more and more analysts and investors are coming to realize the potential of Brazil's smaller domestic stocks.

"People read Brazil as a resource play, but the biggest component of the country is services," Mick Gilligan, director of fund research at Killik & Co, told The Financial Times. "That's not reflected in the stock market so this fund is a way to get exposure."

Gilligan warns, however, that there is no small-cap index in Brazil, making it difficult to tell exactly how the market has performed.

Julian Thompson, an emerging markets specialist at Threadneedle, has overweight positions in Brazil. He told the FT that Brazil's market still trades at a lower multiple of earnings than other emerging markets, such as China and India, but thinks it will re-rate.

"There's a natural prejudice against Latin America as it's seen to be volatile and fueled by debt, but the reality is now very different," he said.

Brazil's balance of payments deficit is less than 2% of GDP and its budget deficit under 4% of GDP - despite the fact that the nation's policymakers signed off on $55.3 billion (100 billion reais) in stimulus measures.

Similarly, at 4.6% inflation remains relatively low, even as the country's short-term lending rate remains at a record low of 8.75%.

Brazilian Finance Minister Guido Mantega said on Monday he saw no threat of imminent interest rate hikes, with no inflationary pressure from demand or supply.

"Companies are looking for capital because they see growth coming and don't want to miss out. We are now seeing some of the strongest and broadest deal flow pipeline since our fund began in 2001." Nick Wollak, who oversees $150 million in private equity for Axxon, told Bloomberg. "For both multinational strategic investors and private equity firms, Brazil has become a place where you have to have exposure going forward."

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