(Bloomberg) -- One of Brazil’s most revered investors is bracing for a longer period of high inflation and elevated interest rates as leading presidential candidates double down on increasing public expenditures, jeopardizing the country’s fiscal outlook.

“Almost every single Brazilian presidential election held since the country’s redemocratization was binary,” Luis Stuhlberger, chief executive officer and chief investment officer at Verde Asset Management said at an event Tuesday. “This time around, investors consider them to be both bad candidates -- each in their own way.”

Bankers Cringe at Both Choices in Brazil’s October Election

Former president Luiz Inacio Lula da Silva, who leads all polls for the October vote, has been calling for more public spending and a potential review of economic reforms undertaken by Michel Temer’s government even as his aides say the left-wing leader will not toss fiscal responsibility out the window. His opponent, President Jair Bolsonaro, has yet to convince investors that his administration’s recent spending splurge is only temporary as he seeks to boost approval ratings before the election. 

“Brazil’s spending cap rule became public enemy number one for both Bolsonaro and Lula -- and that’s a serious problem,” Stuhlberger said about the rule that limits the growth of government expenditures. “We know that inflation and rates will be higher if the winner comes up with policies aiming at boosting spending -- even if that doesn’t appear in the first year.”

Odds of reforms moving forward from 2023 on are low, according to Verde’s chief economist Daniel Leichsenring. “The outlook is bleak,” he said at the same event. “Now the debate is: what’s the magnitude of the setback factored in?”

In the meantime, Verde has been keeping about 18% of its portfolio invested in Brazilian stocks, betting that most of the bad news is already priced in. 

Brazil Election Trade Is Too Murky for $5.7 Billion Hedge Fund

Brazil’s Ibovespa trades at about 6.1 times forward earnings, well below its 10-year average of 11.6 times, battered by the prospect of a faster US interest-rate hike as well as fiscal and election worries at home. The central bank’s sharp monetary tightening -- bringing the Selic rate to 13.25% from 2% in less than 16 months -- had locals rotating away from equity and hedge funds and returning to fixed-income assets. 

“We’re long Brazilian stocks simply because they’re quite cheap,” Verde’s portfolio manager Luiz Parreiras said at the same event. “We’ve been trying to invest in companies that we judge to be big winners regardless of any macro or political scenario.”

Utility Equatorial Energia SA, pulp maker Suzano SA, car-rental firm Localiza Rent a Car SA, cash-and-carry chain Assai and health-care operator Hapvida are among the fund’s favored local stocks. Banks are also “super cheap” and the fund resumed investments in the sector, according to Parreiras. 

Verde, which has Credit Suisse Group AG as a minority holder and oversees over 40 billion reais ($7.6 billion), also has bets on oil and gold, and likes miner Vale SA’s perpetual bonds. 

The asset manager’s flagship fund has posted a return of more than 19,900% in local currency terms since its 1997 inception. It’s up 8.3% this year, trailing a basket of peers but beating the CDI benchmark rated used by the industry by more than three percentage points. 

Here are Verde’s views on other topics:

  • Parreiras on global stocks: “There was a certain exaggeration with growth stocks, which was adjusted. It’s not a walk in the park, but the valuation of US stocks is attractive. That doesn’t mean prices can’t get even more attractive.”
    • “Historically, there’s a bottom in the US market when: 1) the Fed alters its monetary policy or 2) when there’s a cyclical rebound in the economy. It seems the Fed will take longer to change its policy amid a sticky inflation, but we’ll monitor a potential economic low”
  • Stuhlberger on crypto: “I built a position in the Hashdex Nasdaq Crypto Index ETF, surfing a two-, three-month trend, but sold it when prices were up. The crypto debate ends up reflecting the search for safe havens”
  • Leichsenring on Brazil election: “Our models point to a high probability of Lula being elected, although by a small margin”
  • Parreiras on Petrobras: “We prefer to be long oil prices rather than being long Petrobras given the election challenges”

(Updates with the fund’s year-to-date performance, additional comments starting in 10th paragraph)

©2022 Bloomberg L.P.