Continued Confidence in Brazilian Equities

In 2023, Brazilian equities experienced significant growth, with the Bovespa Index rising by 22.3% for the year, approaching its all-time high. This performance is notable given the initial challenges faced at the start of the year, including a new political cycle, a weak economic outlook, and fiscal risks. However, these concerns did not materialize to the extent anticipated by the market. This perspective was supported by the EME equity team's findings during their Q1 2023 visit to Brazil. Contrary to the local sentiment, their interactions with companies indicated strong fundamentals and positive forward guidance. Additionally, valuations were at historical lows, influenced by domestic political and fiscal uncertainty.

Key Factors Behind the Positive Performance in 2023:

• Economic Improvement: The economic outlook improved more than expected. GDP growth, initially forecasted at 0.8%, was revised upwards to over 2.5%, driven by a resilient economy and a robust agricultural sector. Reforms implemented since 2016 have been instrumental in supporting this growth.
• Political and Fiscal Stability: The concerns regarding economic policies and political changes at the start of the year were allayed. Government spending was managed effectively, and the independence of the Central Bank was maintained.
• Monetary Policy and Inflation Control: The disinflation process that began early in the year allowed the Central Bank to initiate interest rate cuts in August 2023. This action placed Brazil ahead of its global counterparts, bringing the year-end inflation to 4.62%, within the target range.

Headline and Core IPCA Forecasts

Source: IBGE, BGB and J.P. Morgan. Data as of November 2023. Any forecasts shown are for illustrative purposes only and not intended as a prediction of future results.

Why We’re Optimistic in 2024:

• Monetary Policy: Continuation of interest rate cuts is anticipated, with the terminal rate expected in the single digits. This is likely to have a positive impact on equities.
• GDP Growth: The GDP growth forecast for 2024 is around 1.8%. Despite a lower contribution from agriculture, the easing monetary cycle and a resilient labor market are expected to support growth.
• Valuations: The Bovespa Index continues to trade at attractive valuations, with a forward P/E of 8x, below the 15-year average, indicating growth potential. Brazil stands out for its P/E and PEG ratios. In bull markets Bovespa has traded at 14-15x and in bear markets at 6-7x, so current valuations are pricing a bear case scenario which is not what recent indicators and showing.

Brazilian Equities Remain Undervalued After 2023 Rally

Source: Bloomberg as of 12/31/23.

Top Performing Brazilian Companies:

• JSL (3.58% of Fund net assets^*), standing as Brazil's largest logistics platform and quintuple the size of its nearest competitor, showcased impressive growth and enhanced operational efficiencies throughout the year. Despite its substantial size, JSL holds just 1% of the market share, highlighting the significant potential for further expansion in this highly fragmented sector. This year, the company made notable strides in improving cross-selling opportunities with its existing client base, indicating ample scope for continued growth. With years of experience in logistics and effective pricing models that distinguish it from its competitors, JSL is well-positioned in a market with considerable untapped potential. Since its IPO, JSL has doubled in size, presenting a substantial opportunity to further compound its growth in the coming years.
• MercadoLibre (“MELI”, 5.27% of Fund net assets^*), Latin America's leading e-commerce platform, is also making significant strides in the fintech sector. In the past year, it saw substantial growth, especially in Mexico and Brazil, consistently increasing its market share even amidst new competition. The company's robust ecosystem, which includes efficient logistics, a diverse product range, and strong credit services, has created a unique network effect, ensuring continued growth across the region. Additionally, there's notable potential in advertising, where MELI is approaching 2% of its Gross Merchandise Volume, suggesting room for expansion compared to larger players like Amazon. This momentum is expected to carry forward into 2024, highlighting MELI’s continued growth trajectory.

Emerging Markets Fund Positioning

In 2023, the Emerging Markets Fund adopted a strategic approach by being overweight in Brazilian equities, a decision that played out favorably. Brazil emerged as the Fund’s largest relative contributor to performance by country, with both allocation and stock selection boosting returns. In other words, both our overweight to Brazil and our stock selection within Brazil significantly helped returns.

Top 10 Country Over/Underweights vs Benchmark

Source: FactSet as of 12/31/23.

As we move into 2024, we continue to demonstrate confidence in Brazil's growth trajectory. It remains our largest overweight position compared to the benchmark, reflecting our belief in the sustained momentum of the Brazilian economy and the relative discount that companies like JSL and MELI represent. These companies embody our S-GARP philosophy, showing strong structural growth at a reasonable price.

Conclusion

Despite initial uncertainties, 2023 was a year of significant achievement for Brazilian equities, and the outlook for 2024 remains positive. Factors such as continued rate cuts, GDP growth, and attractive valuations present a favorable environment for the Brazilian market. Companies like JSL and MercadoLibre exemplify this growth potential, and, combined with their reasonable valuations, are prime candidates for investment for our S-GARP strategy.

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