The five-week rally in Brazilian stocks has left valuations approaching their highest levels on record relative to emerging-market peers.
An MSCI Inc. gauge of the country's shares is trading 12 per cent above a measure of developing-nation equities, according to data compiled by Bloomberg based on estimated earnings. That's the widest margin since 2006, when the gap surged in the midst of a commodities-led boom in Latin America's largest economy.
Now, with Brazil in its worst economic slump in a century, traders have pushed up prices on speculation the country is getting closer to a change in government that would put an end to the political quagmire preventing Congress from focusing measures needed to boost growth. Concern that the impeachment of President Dilma Rousseff would be a lengthy and complicated process has some traders saying that the market rally has become exaggerated, with the Ibovespa 23 per cent above its five-year average.
"If you look at valuations for companies taking into account that Dilma is in charge, it's expensive," said Wagner Salaverry, a partner at Quantitas Gestao de Recursos SA in Porto Alegre, Brazil, which oversees 22 billion reais ($6.1-billion U.S.) of assets. "Current valuations will only make sense if the impeachment comes. Obviously, we don't know that for sure at the moment."
Brazilian stocks have soared even as corporate credit quality deteriorates at a record pace amid a collapse in both industrial production and retail sales. Most of the Brazilian companies that have reported fourth-quarter results fell short of analyst estimates.
The equity rally sent the valuations of companies such as pulp producer Klabin SA and retailer Lojas Americanas SA to the highest levels in emerging markets relative to their peers. Petroleo Brasileiro SA, the oil producer at the centre of Brazil's largest corruption scandal, has surged 82 per cent since Feb. 12, pushing its multiple 54 per cent above the average of the past five years. Valuations for Brazil's raw-material companies are three times the average for developing-nation counterparts.
Meanwhile, shares of more defensive industries that are best positioned to withstand a prolonged economic slump, such as health-care and consumer staples, have trailed the overall market during the rally. Their valuations are below their developing-nation peers.
The political chaos in Brazil, marked by street protests and legal battles, has also amplified swings in the nation's assets, sending the Ibovespa's volatility to the highest level in more than a year. Some of the world's biggest investment banks, including Goldman Sachs Group Inc. and Banco Mizuho do Brasil SA, have said that for a fresh rally to take hold, there needs to be firm evidence Brazil is on the path to recovery.
"The world is not going to change overnight," said Peter Lannigan, an emerging-market strategist at CRT Capital Group LLC in Stamford, Connecticut. Investors are realizing that, whatever happens to the government, Brazil "will still face the same sort of challenges. None of that changes just because you get a new president."