A surprise result Sunday would generate upside risk for Brazilian stocks

The Bovespa stock-market index has rallied 30% in the last 12 months.

The Brazilian presidential election takes place this Sunday and it's on a knife edge.

Polls show the incumbent Lula da Silva with a narrow lead over Flavio Bolsonaro but well within the 5% margin of error. One specialist emerging market fund manager thinks the vote presents an asymmetric risk profile: a win for Lula may be greeted with a modest decline of a few percent in stocks but a win for the challenger, Bolsonaro, would be greeted with a sharp rally, perhaps as much as 10%.

Sunday's ballot is a near-repeat of the 2022 election when Lula won a third term in a contest against Bolsonaro's father, Jair, and hot-button issues for voters focus on many of the same themes in terms of both style and policy this time round.

Interestingly, U.S. prediction markets Kalshi and Polymarket, both of which are banned in Brazil, indicate victory for Bolsonaro by a wide margin of around 15 percentage points.

If no single candidate bags the 50% of the vote required for outright victory then a run-off between Lula and Bolsonaro, excluding fringe candidates, takes place Oct. 25. This might be enough to prompt a surge in stocks as commentators predict Bolsonaro may scoop up some of those floating voters in a second ballot.

In an interview with MarketWatch Thursday, specialist emerging market fund manager Malcolm Dorson discussed the potential outcomes of Sunday's ballot and the opportunities it presents to investors. Dorson is the head of the active investment team and a senior portfolio manager for Global X exchange-traded funds.

As the fund manager for the Global X Brazil Active ETF BRAZ, Dorson is well-positioned to assess the prospects for the Bovespa BR:BVSP benchmark index. So far in 2026, Brazilian equities have delivered a 16% return while the real's (USDBRL) appreciation against the dollar has added another 5% to that for international investors.

However, Bovespa has still underperformed the broader emerging markets index EEM which has increased by almost 19%, partly because of its heavy weightings of technology and semiconductor stocks that aren't available in Brazil.

Brazil's index is dominated by commodity plays and major banks with a relative dearth of technology exposure. This may explain why emerging-market investors are generally underweight Brazilian stocks within the MSCI benchmark. Brazil should make up 4% of a neutral portfolio but Dorson believes most specialist emerging-market funds own far less than that.

Dorson highlighted that in August, for example, international investors pulled BRL18 billion ($3.4 billion) from Brazilian stocks, following on from major redemptions in May and June. However, the recent narrowing of the polls in Bolsonaro's favor has been viewed positively by international investors who then poured BRL 8 billion back into the market over the month of September.

Investors are presented with a clear policy differentiation between Lula and Bolsonaro with the latter seen as more market-friendly. Bolsonaro advocates ending automatic wage increases for retirees, implementing spending cuts and reducing the size of government. Many commentators regard his politics as being molded in the style of other right-wing populists like Donald Trump or Javier Milei.

Flavio's candidacy has been presented as a less extreme and more socially normative version of his father's policies, according to Dorson. While Trump has supported the Bolsonaros, father and son, his relative unpopularity in Brazil has meant his explicit backing has been less prominent than it was in 2022.

Lula, meanwhile, traditionally regarded as a more left-wing politician, would represent more of the same broadly, with a push for wealth redistribution, environmental policies and targeting real spending growth of 1.5%-2.5% annually.

Dorson is not alone in predicting a surge of hot money flows into Brazil in the event of a Bolsonaro victory, or even the likelihood of it occurring during a second-round runoff on October 25. Robin Brooks, for example, senior fellow at the Brookings Institution, discussed the potential for a spike in the real against the dollar in a posting on X Wednesday.

Brooks wrote: "Markets haven't rewarded this with a stronger Brazilian Real because they don't like Lula, but a win by Bolsonaro could change all that. $/BRL would quickly go to 4.80 or lower if he wins." It's worth noting that with the boom in commodity prices in 2026 Brazil is posting massive trade surpluses every month.

The upside potential is clear to Dorson. He pointed out the potential for significant interest rate cuts in Brazil where real rates are among the highest in the world at around 9.5%. The Selic policy rate is 13.5% with inflation oscillating around 4.5%. Moreover, the market is cheap in valuation terms with a price-to-earnings multiple of around 8-9 times, compared to the emerging market average of 11-12x and the S&P 500's SPX 19 times, according to FactSet.

In the last twelve months, the Global X Active Brazil ETF has returned 27.65% compared to 27.09% for the iShares MSCI Brazil ETF EWZ.

Among the stocks Dorson thinks may benefit from a positive result this Sunday, he highlighted are finance sector plays BTG Pactual (BR:BPAC11) and Itausa (BR:ITSA4) and housing/construction stock Direcional (BR:DIRR3). These last two stocks offer dividend yields of almost 9% that may prove appealing if rates start to fall.

-Jules Rimmer