Brazilian Stock Exchange braces for historic post-election crash

The Brazilian stock market is facing a tough opening today. Investors had bet en masse on a right-wing winner, but sitting President Lula won the presidential election yesterday. That miscalculation is now settled in one go, although the blow is less than the first figures suggest.

Outside Brazil, you can already see how hard the blow is coming. A Tokyo-traded index tracker with Brazilian stocks dropped to 16 percent last night. That's the biggest drop in one day since 2020.

Such a tracker, also known as an Exchange-Traded Fund (ETF), is a stock exchange fund that tracks a basket of shares. The American iShares MSCI Brazil ETF fell even more sharply in the after-market trading on Sunday evening, with a loss of more than 18 percent.

“It is going to be a tough day. The market is going to reprice everything,” says Bruno Funchal, CEO of asset manager Bradesco Asset Management.

However, the headline figure does not tell the whole story. The American ETF calculates in dollars, and according to the futures market, the Brazilian real is losing more than 10 percent against the dollar. If you subtract that currency loss, a price drop of about 9 percent remains when calculated in reals.

This is in line with the estimate of the stock exchange company Monte Bravo. According to that company, the Ibovespa can drop 11 percent in the first hour.

Investors had been counting on a government that would cut government spending, and that is not happening now. That is where the core of the panic lies, because Brazil has been spending more than it comes in for years.

The government is filling that deficit with loans, and the national debt is now above 80 percent of the economy. Those who borrow so much have to offer investors high interest rates.

Compare it to a household with a heavy debt: the higher that debt, the more interest the bank charges. As a result, Brazil has one of the highest real interest rates in the world, i.e. the interest after deduction of inflation.

That expensive interest rate puts a brake on the economy. Companies borrow more expensive and consumers spend less, which depresses profits and thus share prices.

Bolsonaro promised to address spending. A smaller deficit means less borrowing, and then interest rates can fall.

After his win in the first round on October 4, therefore, billions of foreign money flowed into Brazil. The Ibovespa, the main index of the São Paulo stock exchange, rose by almost 8 percent.

But Luiz Inácio Lula da Silva won yesterday, with 51.79 percent of the vote. Investors do not expect any major cuts from him, and at the end of 2024 doubts about his spending sent the real to a record low.

This also removes the hope of lower interest rates. Those who had counted on Bolsonaro come home from a cold fair and take their money away again. That doubles the coin, because foreign investors exchange their reais for dollars on departure.

Guilherme Abbud, CEO of asset manager Persevera Asset Management, expects little patience from the market. “Initially, the prospect of a major turnaround in economic policy would disappear. Lula could end up being more careful with spending, but the market probably won't give him the benefit of the doubt.”

The fair in São Paulo opens at 14:00 Dutch time and traders take a circuit breaker into account. This is an automatic emergency brake that stops trading if the price falls too high.

If the Ibovespa drops by 10 percent, the trade stops for half an hour. At 15 percent, a break of one hour follows, and at 20 percent, stock exchange operator B3 determines how long the silence lasts. The emergency brake was last applied at the beginning of 2020, during the corona crash.