Exuberant Brazil

Brazil’s stock market, as measured by the inflation-corrected Bovespa index, has more than quadrupled in value since President Luis Inácio Lula da Silva’s first election victory in October 2002, and is now at almost twice the peak achieved in 2000. In comparison, the inflation-corrected Shanghai Composite only doubled during this period, while the American stock market, as measured by the inflation-corrected Standard and Poor’s 500, increased only 50%. Indeed, the United States has never experienced a fourfold increase in stock prices in less than five years, even during the late 1990’s bubble.

Given that Lula is an avowed leftist who counts Hugo Chávez and Fidel Castro among his friends, Brazil’s performance is all the more surprising. How could he manage to preside over such a spectacular stock-market boom? Are Brazilians too exuberant? Might it be time for foreign investors to pull their money out?

Stock-market movements are certainly hard to explain, but there are reasons to believe that Brazilians might be rationally exuberant. Corporate earnings in Brazil have gone up roughly as fast as stock prices. With the price/earnings ratio remaining stable and moderate, the stock-market boom does not appear to reflect merely investor psychology.

On the contrary, the real question is why the increase in stock prices has not outpaced growth in corporate earnings. After all, in the 1990’s, the US stock-market surge (as in many countries) was fueled by record-high price/earnings ratios. In 1998, the price-earnings ratio in the US was 24, compared to a historical average of around 15. By contrast, the run-up in stock prices in Brazil started from a very different point, with the price-earnings ration as low as six in 1998.