Jair Bolsonaro's presidential victory in Brazil last year propelled Brazilian stocks to a sharp rally to close out a wild 2018. But the new president has a small time window to push through key reforms.
The iShares MSCI Brazil exchange-traded fund (EWZ), which tracks a basket of Brazilian stocks, jumped 13.25 percent in the fourth quarter. Meanwhile, the iShares MSCI Emerging Markets ETF (EEM) dropped nearly 9 percent in that time period. Brazil's Bovespa index also gained 10.8 percent in the final quarter of 2018.
Global investors cheered Brazilian stocks toward the end of last year amid expectations that Bolsonaro will be able to push through changes to help the country's economy recover from a devastating recession. However, time is of the essence for Bolsonaro if he wants to keep this momentum going.
"The window to pass reform in Brazil is never open for long," said Elizabeth Johnson, a managing director at TS Lombard, in a note Friday. "Sentiment could shift if the administration fails to make headway on pension reform over the next six months, thereby missing this historic opportunity."
Brazil's economy has struggled for growth in recent years. Its economy contracted throughout 2016 before turning around in 2017. However, economic growth has struggled to stay near 1 percent over the past two years and has not broken above 2 percent in about five years.
One key issue hurting the Brazilian economy is the country's pension system. While most public pensions include a minimum retirement age, the Brazilian system pays high replacement rates — the percentage of a worker's pre-retirement income ultimately paid out by a pension program — and does so at a much lower age. Brazil's current retirement age is 60 for men and 55 for women. This has led to a ballooning deficit.
Bolsonaro has a chance to push through this reform and has made it a priority, said Johnson. He has already suggested raising the retirement age to 62 for men and 57 for women. While this proposal is far less ambitious that of former President Michel Temer's, it shows he "understands the challenges ahead," said Johnson.
Temer originally proposed raising the retirement age to 65 for men and 62 for women. Bolsonaro — a former army captain known for making racist and homophobic remarks — rode a wave of anti-establishment sentiment to win last year's election as Brazilian citizens grew tired of rampant government corruption, increasing violence and meandering economic activity.
That momentum has carried into the new year. According to a recent poll by Brazilian pollster Datafolha, 65 percent of Brazilians believe Bolsonaro's government will be good for the country. Brazilian stocks have also started off 2019 strong, with EWZ rising nearly 2 percent through the first four sessions of the year.
"Market sentiment will remain positive for the next six months," said Johnson in another note Monday, adding the chances of pension reform passing this year remain strong. "But if the pension reform debate drags on into the second half of the year, the chances of a meaningful pension reform will decline, which would in turn dampen market enthusiasm."