Sergio Goldman: The equity market has reacted in an extremely mature way. Foreigners were very positive from June, when the crisis broke, to September and the Ibovespa index jumped by around 23% during that period. There was a negative reaction in October but that was due to the external market and not the political situation. So far in November, the Ibovespa has accumulated another 3% gain. Although foreigners are aware of the political risk, the liquidity factor was a strong element. Contrary to what many believe, foreigners know the country and the region well. This is not the first crisis they have seen in Brazil.

Local investors reacted differently. Those of us who live here were very concerned at the potential impact because we are closer to events. We watch television, read the newspapers and magazines and it's almost impossible not to be influenced by the headlines. The feeling now is that the worse is over. As long as the government sticks to the main pillars of its economic and fiscal policy, such as fiscal austerity, the external accounts, maintaining a floating exchange rate and the inflationary target system, investors - not just portfolio investors but companies as well - will treat the economic and political areas separately.

Goldman: I expect the 2006 presidential elections to cause much less market nervousness than those of 2002. This is because the main probable candidates - and I don't discount President Luis Inacio Lula da Silva standing again - will have similar macroeconomic policies. The impact on the market will therefore be weaker. Looking ahead, the economy will accelerate gradually. I am positive about the Ibovespa and expect it to end this year at around the current level (31,000 points) and to jump at least 30% in 2006. I believe interest rates will continue their downward trend throughout next year although they will still remain high - above 10% in real terms. We expect them to be slightly below 16% by the end of 2006, with inflation running at 5%. We expect the Real to depreciate gradually toward R$2.40/US$ by the end of 2006. 

Goldman: To increase Brazil's rate of growth in a sustainable way. Brazil is lagging behind other emerging markets and reforms are needed to improve its competitiveness. It needs to be more aggressive on the fiscal side but, since this means cutting public expenditure, we can expect a lot of political opposition. Nothing radical will be done in the next year. Tax reform, for example, is not feasible at the moment but could be tackled in 2007.

Goldman: That's another issue which is unlikely to be raised in the coming year but could be on the agenda of the next government. In any case, the Central Bank is virtually independent. It has shown this in its conservative monetary policy. The Copom has had opportunities to be more aggressive but has chosen not to. We should not expect it to change its behavior in the medium term. 

Goldman: We like banks, consumer stocks, electric utilities and mining. Brazilian banks are extremely efficient and will benefit from the increased demand for credit. Consumption will be boosted by the decline in interest rates, which will benefit consumer-related stocks. In the electricity sector, we have seen more regulatory stability, better capital structures and increased demand for energy as the economy grows. The new energy auction to be held in December will be an important test. Finally in mining, we expect iron ore prices to be readjusted by at least 10% in 2006 which will have a positive impact on CVRD and Caemi's shares.

Goldman: It will certainly affect the way Brazil is seen abroad but the number of incidents of the outbreak has been small. In any case, the two main listed companies, Perdigão and Sadia, export pork rather than beef and should only be affected in a limited way.

Goldman: We think Petrobras shares are very cheap compared with those of other oil companies in the emerging markets, not to mention those from developed countries. Part of this discount is explained by the fact that the company is controlled by the government. This means that it is not flexible in letting domestic prices fluctuate as quickly as changes in the international price, the exchange rate and other variables might demand. However, Petrobras is increasing production and the current share price is still distorted.

Goldman: This government has undergone a learning process and there has been less interference than when it came into office. The government has no money to pay for the large investments needed in sectors like electrical energy and knows that regulatory stability is essential to attract private investors. As a result, it has become very pragmatic. One of the reasons why the outlook for the electrical energy sector is extremely positive is because the regulatory framework has become more stable. The presidents of ANEEL and ANATEL, for example, have spoken publicly about the need to respect contracts.   

Goldman: There are various reasons. The process of reforms which is still in place will create value for Brazilian companies. The economy should accelerate faster than has been observed in the last 10 years or so. Brazilian management has a very good track record and the country is highly competitive in sectors such as steel, mining, pulp and paper and banks. Corporate governance practices are being improved and, finally, the Brazilian stock market is one of the most liquid among emerging markets.

Goldman: First of all, the process of improving corporate governance practices should continue or even accelerate. Secondly, companies should be given incentives to increase the liquidity of their shares by giving more investment options to large investors which want to buy Brazilian shares. Thirdly, more effort should be made to sell Brazil to foreign investors since, as I have already said in another item, there are several strong reasons to 'buy" the country.

Goldman: I do not know what the exact situation is. However, the perception is that companies are committed to complying with SOX. Considering their excellent managerial standards and willingness to improve corporate governance practices, they should be ready.

Goldman: We have 11 analysts covering banks, consumer companies, steel, mining, pulp and paper, telecoms, utilities, transportation, oil, gas, petrochemicals as well as small caps. We do not plan to increase the size of the team but we do plan to increase our coverage from 60 companies now to about 90 companies at the end of this year. We also have a fixed income department and a team of five economists who serve the whole group.

At the end of the day, strategists and analysts are employees of financial institutions. How do you prove to investors that your recommendations are in their interests and not in your employer's interest? 

Goldman: Unibanco is probably the most traditional capital markets house in Brazil. This by itself gives investors confidence to deal with the institution. On top of this, we have the best possible compliance standards, with a large structure in place to guarantee best practices. This is a guarantee to clients that our recommendations are in their best interests.

© John Fitzpatrick 2005