Brazil’s Bovespa stock market was briefly halted after declining 10%. This decline in equities is in reaction to corruption allegations against Brazilian president Michel Temer on Thursday, May 18, 2017.

There are allegations that President Michel Temer, who replaced Dilma Rouseff when she was impeached last year, gave consent to pay off a witness in Brazil’s recent bribery scandal. Temer denies any wrongdoing.

Given President Temer was leading the charge on pension reform, there is speculation that these pension policies will not be changed and that Brazil could slip into fiscal crisis.

OFI Emerging Markets Equity Team Thoughts

Prior to the May 18 revelations, it was a foregone conclusion that the Brazilian Congress would pass necessary pension-reform measures (raise the retirement age, reduce pension fraud in rural regions, etc.). This highly unpopular reduction in pension benefits is necessary to ensure Brazil’s fiscal solvency.

While we believe that the Congress is motivated to make some pension changes, we think the likelihood of meaningful reform declines the closer the country gets to the 2019 presidential election.

Investors have priced in the success of pension reform and expectations that reduced government spending would allow the Brazilian Central Bank to lower interest rates faster and more aggressively. Without pension reform, Brazilian interest rates could not meaningfully decline, which has negative implications for expected growth.

While we were underweight Brazil because we believed equity and currency (Brazilian real) valuations were stretched and fiscal issues were not solved, we will watch the situation in Brazil closely and react appropriately to take advantage of opportunities when presented.

Developing Markets and EMI Exposure (as of 4/30/2017)

Oppenheimer Developing Markets Fund has 6.79% in Brazil and is underweight the MSCI EM Index by 64 bps.

Oppenheimer Emerging Markets Innovators Fund has 6.25% in Brazil and is underweight the MSCI EM Mid Cap Index by 243 bps.

Consistent with our investment philosophy, we did not make structural changes to the portfolio in reaction to this event. We seek to own extraordinary companies within sectors and industries where we see dynamic change. Structural change that will persist over the long term despite short-term political events.

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For more information, download our flyer, Emerging Market Equities: Brazil Update.