Brazil…and Cake: Brunel's 2025 New Year Letter

It is that time of year again where we reflect on last year and cast our minds forward for what 2025 will bring. Unlike investors in Bitcoin or US equities 2024 is a year to forget for those invested in Brazil, whilst Argentina remains a work-in-progress. I hope you enjoy reading…

Our take on Brazil

I must begin my year-end update by rereading the one from last year, and how we were pinching ourselves with excitement as to Brazil’s prospects for 2024. Financial markets have delivered a crushing blow to that excitement with numbers that speak for themselves...

Reflecting on the numbers above, the intellectually dexterous capital raiser will tell you that it’s just a question of timing, the opportunity set has only gotten cheaper and more attractive. The intellectually honest one will admit to being wrong – please indulge me whilst I attempt to do a bit of both. Rather than ruminate on my failings I will first segue (or weave) towards a football metaphor, bear with me…

For many long years I supported UK premier league football club Tottenham Hotspur, a good team, but one that in my lifetime has been fundamentally denied significant victories. Upon moving to Brazil in 2017 I adopted Flamengo as my Brazilian football team, partly due to family history, but they also seemed to be the Man Utd of Brazil (at least Man Utd from the 90’s/00’s). In 2019 Flamengo won the Libertadores (the South American Champions League) as well as the Brazilian League and I discovered (amongst celebrating fans) that winning is great – who knew? Since then, I not only got to cheer on Flamengo winning the Libertadores again in 2022, but their cross-town rivals Fluminense, who won it in 2023 and Botafogo (arguably the Spurs of Brazil) in their Libertadores victory in 2024. So, why am I telling you about this? Cakeism I’m having my cake and eating it. I have become a shameless glory supporter, donning the colours and cheering each of these rival teams to victory. Cakeism strikes me as being behind much of Brazil’s recent maladies…

• Lula wants to spend to boost the economy, without suffering the consequences of financial markets selling down the BRL or pushing up inflation and forcing the Central Bank to raise rates.
• Congress (and the big-centre political grouping that dominates it) wants to maintain their generous federal budget entitlements, further boosting their power, whilst still criticising Lula for the ballooning deficit.
• Bolsonaro does not want to relinquish his hold on the Right of Brazilian politics, wants to run again in 2026 (despite being barred) and, not surprisingly, wants to stay out of prison for his alleged role in plotting a coup following the last presidential election.

Quite simply, our prior view that “the political ‘system’ in Brazil seems to be conspiring to keep politics firmly focused on battling for the economic centre ground” has broken down as each side shamelessly refuses compromise in pursuit of their own objectives.

The simple story for 2024 is one of market frustration with Lula’s perceived reluctance to curb public spending and address rising debt levels. This scepticism has triggered a risk premium on Brazilian assets, pushing yields higher and causing a sharp currency depreciation – which pressures inflation and thereby leading the Central Bank to raise rates. Lula in his desire to ‘deliver’ the country at the end of his term with high growth, low unemployment and low poverty has turned to spending generously on social programs and the public sector, setting a higher minimum wage and continuing to allocate parts of the federal budget to Congress to spend on pet projects. He has increasingly seen financial markets as an adversary and blamed the Central Bank for keeping interest rates high. He recently declared that “no-one in this country, not even the market, has more fiscal responsibility than I do”, which rivals Trump saying he’s “basically a truthful person” for chutzpah from a politician in 2024.

Even when announcing long-awaited planned budget cuts, the government promised to raise the income tax threshold as a sweetener for the middle class, whilst compensatory raises from high earners. A ‘fiscally neutral’ plan in theory, but one that needs to get through a congress with a reputation for protecting the wealthy and well connected, making it highly unlikely in practice.

There is a strange dissonance at the moment as whilst financial markets are seemingly valuing Brazil in a quasi-distressed level, the picture on ‘Main Street’ is thriving, with an economy expected to grow at ~3.2%, generally strong company earnings and unemployment and poverty levels not seen since previous boom times in 2012/13. Anecdotally I have never seen bars and restaurants in both Rio and S?o Paulo as busy are they are now. Structurally the Brazilian economy appears healthy, powered by consumer spending but with positive tailwinds in renewables, tech, O&G and mining (especially critical minerals for energy transition). Agriculture, which has become a powerhouse sector in Brazil in recent years had a tough 2024, due to El Nino linked weather and is expected to bounce back strongly this year. However as financial markets are forward looking, current market weakness augers badly for Brazil’s near-term economic prospects; certainly, base interest rates of 12.25% (and expected to rise) are pressuring companies and consumer spending on credit, and a weak FX directly feeds through to higher prices on food and fuel. The market is forecasting a slowdown in 2025, with the possibility of a technical recession in H2 2025 looking more likely.

What has been interesting is how little political capital Lula has got for the healthy economy and rising living standards. Municipal elections in October saw Lula’s PT party perform poorly, with the Centr?o (big-centre) political parties the winners. Recent polls have shown a steady decline in Lula’s net approval rating.

We predicted last year how attention would soon turn towards the 2026 presidential election, and we have heard lots about the calibre of the next generation of politicians, across the centre-left and centre-right spectrum, with an impressive cohort of governors. Sadly, those hoping for this new generation to take over, ourselves included, are currently left waiting with the prospects looking bleaker.

Lula, despite turning 79, recent hospitalisations and swerving comparisons with Biden remains the most likely candidate for the PT. Recent polls showed 52% of respondents believe he should not run for re-election in 2026, yet despite this he remains the most popular politician in the country by some margin. Bolsonaro, who is currently banned from running in elections until 2030, has taken succour from Trump’s victory and continues to insist that he will contest the next election and try remain the chief protagonist on the Right. This is despite facing criminal charges including falsifying a vaccine certificate,?embezzling luxury jewellery and more?damning charges related to an attempted coup in 2022?that could land him in prison by the year-end. Assuming the bar holds, his son Eduardo has been positioning himself as the likely surrogate. More moderate candidates like the current S?o Paulo Governor, Tarcísio de Freitas, have been distancing themselves from running. If someone put a gun to my head asking for my prediction as to the most likely scenario for 2026, I would gloomily say Lula beating Eduardo Bolsonaro, however there are so many unknown variables that I’m certainly not placing any bets on this eventuality.

Whereas last year we were cautiously optimistic, worrying about what risks could emerge to spoil the party, this year we find ourselves almost in reverse, pessimistic about the medium-term outlook but wondering what might emerge to change the scenario. We have been fielding questions about what are the catalysts that could alter the negative investor perception about Brazil and, frankly, it’s hard as they are mainly dependent on politics, which remains so much in flux…

1. Lula, fearing what runaway inflation and a contracting economy will do to his prospects in 2026 backs down, works with Congress to get spending down and tries to placate the market – possible but this would require quite a volte-face from an increasingly stubborn old man.
2. Lula doubles down on spending, risking a fiscal crisis of credibility but backing his own personal charisma and unpopular opponents to win re-election – unlikely as we have seen how inflation and suffocatingly high rates can lose elections.
3. Congress steps in and takes a greater role in reducing spending, even in the event of a rupture with the PT, a potential impeachment – unlikely as Congress has already watered down PT spending cuts and will not want to be blamed for inflicting hardship on people ahead of elections.

Unfortunately, the feeling is things may need to get worse on the ground before they prompt a concerted change in course from either Lula or Congress, and the next six months will likely see both try to muddle through as they assess their options for 2026.

There are few marginal buyers of Brazilian equities right now, either internationally or within Brazil, as local investors have largely fled equity and hedge funds to high yielding fixed income. What that does mean is that equities are exceptionally cheap right now, with most companies fundamentally sound, even in the event of rising rates and inflation which is not a novelty to most. Of course, further falls are possible, but greater ruptures increase the chances of a more profound turnaround in government…when even us at Brunel are downcast on Brazil equities, could this be the bottom?

Despite this pessimistic prognosis, when asked what gets us most excited about Brazil from an investment perspective we have long since eschewed opportunities predicated on a growing economy, and sought opportunities focused at the confluence of market inefficiencies (often with shortages of capital) and talented managers (of which there are plenty). The current situation of high rates and robust economy is particularly good for distressed and specialist credit strategies. Infrastructure is also a bright spot, where the regulatory framework has remained attractive and macro factors are scaring away global investors, creating opportunities to acquire core assets at very attractive returns.

Argentina Musings

Looking south at our ‘hermanos’ in Argentina provides a curious counterpoint of a country taking the medicine, however bitter. Argentina is emerging as one of the most interesting socio-economic experiments globally as Milei continues to pursue his anarcho-capitalist reform agenda on the country.

There have been some excellent articles explaining the situation in Argentina (FT, The Economist, NYT). To summarize, through Milei’s aggressive policies, inflation has come down dramatically, the government has been posting budget surpluses and the economy appears to be emerging from a recession that began last year. Nevertheless, as expected this is inflicting real pain on the population that had already been suffering falling living standards for over a decade. The share of the population living in poverty climbed 11% in the first half of 2024 to 53%. Thus far, Milei, through his bombastic style, but also some pragmatic compromise, has been able to carry a majority of the population with him, with approval ratings hovering around 50%.

Milei still has a hard task ahead of him, particularly lifting foreign exchange controls without blowing out the FX/inflation, all the while keeping a historically restive population onside. Brave early investors have reaped big rewards so far, yet it is these next 12 months where we will really see the sustainability of Project Milei.

Parting thoughts…

2024 proved a lesson in the capriciousness of Brazilian politicians and the dangers of believing what is good for Faria Lima (Brazil’s Wall St) will be similarly valued by the wider country. We are hoping for a turnaround in market perceptions on Brazil, but for that to happen we need the cakeism to stop and for some difficult decisions to be taken. Brazil would have a long way to fall to reach the situation of Argentina as of last year, but the model remains instructive and hopefully can be addressed much earlier.

Alas, whilst markets made 2024 a difficult year, we must have our cake where we can find it. Summer has started, Carnaval (which everyone should experience at least once in their lives) is in March and Carioca (Rio based) football teams remain victorious and great fun to watch. As for less frivolous things to celebrate, we await in hope.

There is no shortage of talented people in Brazil, nor shortages in inefficiencies. At a micro level this creates attractive investment opportunities. At a macro level this creates tremendous scope for things to improve without the need to reinvent the wheel. The success of the Central Bank payments system PIX and the return of swimmers to famous Rio beaches in literally decades following sanitation privatisations and investment are but two examples of the benefits that flow widely when government gets things right.

Predicting how exactly things will improve is hard right now, imagining how they could, is a piece of cake.