As emerging market investors become more discerning, there has been a growing focus on the outlook for individual countries, since country factors account for roughly 40 per cent of the total return in such markets.
Perhaps unsurprisingly, political change is a recurring theme. The election of new leaders, seen as more likely to embrace the reforms required to kick-start faltering economies, has acted as a catalyst for a market rerating in a number of countries – notably Mexico, India and Indonesia.
Following contractions in GDP of 0.2 per cent in the first quarter and 0.6 per cent in the second quarter, Brazil is technically in recession.
Dilma Rousseff has been president since 2010, overseeing a challenging period for the economy. Her approval ratings hit lows in 2013, with street protests triggered by rises in the cost of living and poor public services. In spite of an improvement in these ratings towards the end of 2013, her fortunes have ebbed and flowed this year.
The prospect of political change has been a key driver for the Brazilian market this year. Rises and falls have been even more pronounced in the share price of some companies; Petrobras is a particularly high-profile example of a company whose fortunes are very susceptible to politically sensitive decisions.
Markets rallied strongly from mid-March through to the end of September, anticipating that Ms Rousseff’s very low approval ratings would result in defeat and the election of a more business-friendly presidential candidate. Latterly this had been Marina Silva, who was elected leader of the Socialist Party following the death of Eduardo Campos in a plane crash. But she came third in the first round of polling, with only 21 per cent of the vote.
The beneficiary of her collapse was Aecio Neves, leader of the Brazilian Social Democracy Party, broadly seen as the most centrist and business-friendly candidate. He received 34 per cent of the vote, compared to Ms Rousseff’s 41 per cent.
Observers suggested that he may have sufficient momentum to overtake the president in time for the second vote on October 26. The prospect that Mr Neves or Ms Silva might usurp Ms Rousseff has buoyed the Brazilian equity market over the past six months. But the uncertainty over victory ahead of the elections has also greatly increased the volatility.
Many investors believe that the stakes for Brazil are high. It would be misleading to read across directly from Mexico to Brazil, with the former being much more sensitive to a strengthening US economy, and the latter susceptible to Chinese growth and swings in the commodity supercycle.
However, Mexican president Pena Nieto is driving through economic reform, notably with changes to legislation governing the oil and gas industry that will enable foreign investment. Mexican markets have rerated and now trade on 18 times 2015 earnings, in sharp contrast to Brazil, anchored on 11 times forward price to earnings.
With Brazil representing nearly 12 per cent of the MSCI Emerging Markets index, the presidential election developed into a high-stakes game for emerging market investors. In spite of expectations that those who voted for Ms Silva in the first round would support Mr Neves, Ms Rousseff still managed to defeat her more market-friendly rival. In the final run-off, she secured 51.6 per cent of the vote.
