- The Fund is overweight the allocations to Brazil – and we plan to keep that allocation for now.
- We believe Brazil now has a credible, independent, policy-driven central bank.
- It is likely to be late October before there is a clearer picture of reforms and the potential economic impact.
Brazil recently resolved a long-running national trauma by impeaching its president and confirming her replacement. The action opens the door for new efforts to revive the country’s economy.
Brazil’s Senate on Aug. 31 impeached President Dilma Rousseff, convicting her of breaking budget laws by manipulating accounts to minimize the size of the deficit. She was removed from office and replaced by Michel Temer, who was vice president and had filled in since Rousseff’s suspension in May. The next general election is set for October 2018.
Rousseff won re-election in 2014 and her time in office was a mixture of popular success and economic failures. It ends 13 years of government leadership by the leftist Workers’ Party, an era when Brazil’s economy boomed and millions of citizens reached the middle class.
Conversely, Rousseff’s tenure includes Brazil’s worst recession in decades and an ongoing, two-year corruption scandal that has touched a wide range of business executives and politicians. The country also has recorded its highest unemployment rate in more than a decade — more than 11%, meaning at least 11 million Brazilians looking for work. We think unemployment will continue to rise for at least the next few months.
Temer has indicated he now hopes to put the economy back on track, but in part through unpopular austerity measures. He also has proposed a national retirement age of 65 years old for all, breaking the link between annual minimum wage increases and national pension payments, and mandatory annual increases on all federal expenditures on public services.
Brazil allocation and holdings
The Fund still is overweight relative to its benchmark index in its allocation to Brazil — and we plan to keep that general weighting for now. The markets have been volatile this year, with huge swings in asset prices, and we expect this to continue. We are keeping a close eye on the country and its markets, and will adjust sector weights and overall weights as necessary.
In selecting Brazilian securities for the Fund, we have put an emphasis on companies that we believe can benefit from lower interest rates — including banks such as Banco Itau, Banco Bradesco and Banco do Brasil, as well as shopping-mall owner/manager BRMALLS — and state-owned enterprises that can benefit from reform programs — such as Petrobras, mining company Vale SA and water industry company Sabesp. The Fund also invests in growth companies that we think can benefit from positive secular trends irrespective of the political backdrop. These include drugstore chain Raia Drogasil, pharmaceutical and consumer-goods maker Hypermarcas SA and Kroton Educacional, the largest private educational company in the world.
Potential tailwinds offer support
Brazil this year has absorbed the difficulties from political and corporate scandals while celebrating the successes of the Olympic Games in Rio de Janeiro. As we look ahead, we believe there are more tailwinds than headwinds for the country's economy:
- Brazil’s central bank, Banco Central do Brasil (BCB), has opened the door to rate cuts, according to the minutes of its latest meeting. The SELIC rate — the BCB’s target policy rate — is 14.25% and inflation is more than 8%. BCB President Ilan Goldfajn has made it clear that he will not support interest rate cuts until he confirms that an uptick in food inflation is temporary, a recent downward trend in services inflation is real and the government can make fiscal adjustments. The central bank has a longstanding target inflation rate of 4.5%, plus or minus 2% — a fairly wide range. We believe Brazil now has a credible, independent, policydriven BCB president in Goldfajn, which bodes well for future actions.
- Industrial confidence and production have been positive month-on-month for four consecutive months. Inventory levels are very low and we think the rebuilding under way in the supply chain will provide a needed upward boost to Brazil’s gross domestic product (GDP) in the coming quarters. Annual GDP growth in Brazil has averaged 2.7% since 1991, but ranged from a high of 10.1% in first-quarter 1995 to a low of -5.90% in fourth-quarter 2015. Brazil’s economy shrank 3.8% year-on-year in second-quarter 2016 after declining 5.4% in the first quarter.
- We think Brazil will dramatically open its doors for foreign direct investment, with federal and state concessions for infrastructure logistics (airports, seaports, toll roads), sanitation (water, sewer) and electricity (transmission & distribution, generation). We also think the state-owned oil company, Petroleo Brasileiro SA (Petrobras), will be the beneficiary of changes to how it is required to operate, including reductions to local content and an end to a requirement to be the general contractor on selected projects. We believe these will be significant changes for the country overall. Prior to becoming embroiled in its own corruption scandals, Petrobras represented 10% of Brazil’s GDP.
How far, how fast?
As is the case in the U.S. Congress, there are both lower and upper houses in the National Congress of Brazil and congressional subcommittees often are responsible for specific legislative activities. With more than 30 parties represented in its congress, Brazil is a country that is ruled by coalitions.
We think these factors mean any reform process will be slow and also will be hampered initially by major local elections scheduled for October. In addition, Temer will be on the road in September for G20 meetings in China and U.N. sessions in New York. In our view, it is likely to be late October before there is a clearer picture of Brazil’s reform programs and the potential impact on its economic future.
Information is subject to change and is not intended to represent any past or future investment recommendations. The MSCI Emerging Markets Index represents large- and mid-cap stocks in 23 emerging-market countries. It is not possible to invest directly in an index.
Sources: Trading Economics.com, Instituto Brasileiro de Geografia e Estatística (IBGE) for GDP data; Bloomberg.com, “Dilma Rousseff Ousted in Historic Brazil Impeachment Trial,” Aug. 31, 2016; The New York Times, “Dilma Rousseff Is Ousted as Brazil’s President in Impeachment Vote,” Aug. 31, 2016
Past performance is not a guarantee of future results. The Waddell & Reed Advisors Funds, the InvestEd Portfolios and Ivy Funds Variable Insurance Portfolios are managed by Waddell & Reed Investment Management Company and distributed by its subsidiary, Waddell & Reed, Inc. Ivy Funds are managed by Ivy Investment Management Company and distributed by its subsidiary, Ivy Funds Distributor, Inc. Review the Corporate Entities page for detailed information about Waddell & Reed, Inc's subsidiaries.
Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of a mutual fund. This and other important information is contained in the prospectus and summary prospectus, which may be obtained here or from a financial advisor. Read it carefully before investing.
Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magniﬁed in emerging markets. Investments in countries with emerging economies or securities markets may carry greater risk than investments in more developed countries. Political and economic structures in many such countries may be undergoing signiﬁcant evolution and rapid development, and such countries may lack the social, political and economic stability characteristics of more developed countries. Investments in securities issued in these countries may be more volatile and less liquid than securities issued in more developed countries. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.
IVY INVESTMENTSSMrefers to the financial services offered by Ivy Distributors, Inc., a FINRA member broker dealer and the distributor of IVY FUNDS® mutual funds, and those ﬁnancial services offered by its affiliates.