Morgan Stanley downgrades Brazil and sees stock market up to 30% lower after Lula's re-election and circuit breaker

Morgan Stanley downgraded its recommendation for Brazil and warned that Brazilian shares could fall between 20% and 30%, with a strong difference between sectors. The report, released on Monday, October 26, coincided with the stock market's first circuit breaker in six years, after Lula's re-election, according to the Clube do Valor channel.

In that session, the Ibovespa opened with a sharp drop and closed with a decline of 13.88%, after falling more than 17% at the day's low, when it reached 170 thousand points. According to presenter Felipe Almeida, the stock market continued to fall in the following days. The biggest daily drop in the series, he recalled, was 15.83%, on September 10, 1998, during the Russian crisis.

What the report says

Signed by strategists Nicolage Lipman and Júlia Nogueira, the note moves Brazil from overweight to equalweight, a more neutral view. The bank cites the high probability of continuity of economic policies and the increase in fiscal risks.

The document describes asset impairment in three stages. Firstly, the market returns to the optimism of the first round: the dollar has already tested R$5.50 and future interest rates have once again surpassed 14%. In the second, the market starts charging a premium for fiscal risk, which would take the dollar close to R$5.60 or R$5.70 and future interest to 15.5%.

In the third stage, if the government does not signal adjustments to public accounts in the coming weeks, the dollar could reach R$6 and future interest rates could reach 16.5%. This stage is called fiscal dominance: a situation in which the debt is so heavy that raising interest rates to contain inflation is no longer sufficient. According to the bank, Brazilian assets have only priced in this risk twice in 20 years.

Despite the pessimistic tone, the report does not project a drop in company profits, but rather few revisions in estimates for 2027. The problem, in the bank's reading, is how much the investor agrees to pay for these profits. On October 23, the stock traded at 9.6 times earnings; in the adverse scenario, it would fall to 6.2 times by mid-2027, which would take the Ibovespa to around 130 thousand points, a level last seen at the end of 2024. The bank became more optimistic about Vale, Embraer, JBS and Suzano, which tend to benefit from a stronger dollar.

Public accounts and divergences

For the presenter, the fiscal hole does not have a single person responsible. He cited the PEC Kamikaze of 2022, under the Bolsonaro government, which took more than R$41 billion outside the spending ceiling, and the PEC of the transition, under the Lula government, which increased the ceiling. He also cited the debt close to 83% of GDP, interest payments close to 9% of GDP in 12 months and the nominal deficit of almost 10% of GDP.

The report also points out that more than 91% of spending is already mandatory and that, with the fiscal adjustment postponed, gross debt would reach 106% of GDP in 2035. A factor of uncertainty is the name of the next Finance Minister: the governor of Piauí, Rafael Fonteles, is the most popular, and divides opinions in the market.

Not everyone shares the pessimism. According to Clube do Valor, there are analysts who see an opportunity in the correction, pointing out that a more right-wing Congress could slow spending agendas. In the opinion of one of them, the Brazilian market historically finds points of stabilization after political shocks, and a rebound tends to be strong if the scenario improves. The presenter recalled that, in May 2025, Morgan Stanley itself projected 189 thousand points for mid-2026, a level that the stock exchange surpassed by surpassing 206 thousand. In the channel's view, projections are bets, and the investor must separate his opinion as a citizen from his decision as an investor, with a diversified portfolio and defined allocation.

Automatically translated from Portuguese.