Brazilians have re-elected President Dilma Rousseff by a slim margin of victory over the pro-business candidate Aecio Neves. But the real losers appear to be investors in the stock and currency markets, which plunged the day after the election. The negative sentiment surrounding Brazil makes for an excellent contrarian investment. The bargain-buying opportunities don’t present themselves when everyone is optimistic.

The flagship iShares MSCI Brazil Capped (EWZ) dropped 5 percent while U.S.-traded shares of Petroleo Brasileiro Petrobras (PBR) -- a highly government-regulated company -- burned off 14 percent.

One of the worst-performing stock markets this year, the MSCI Brazil index had already tumbled 15 percent the past three months. In the year through Oct. 24, it had crashed 16 percent in the face of recession, free falling commodity prices, a weakening currency and rampant inflation. And at the same time, it had to contend with China’s economic slowdown, volatility from the Federal Reserve tapering quantitative easing and Argentina’s debt crisis. Latin America’s largest economy contracted 0.2 percent quarter over quarter in the first quarter and dipped 0.6 percent in second quarter after having expanded at an average rate of 0.72 percent since 1996, according to Trading Economics.

“Domestic challenges including reduced business and consumer confidence, declining investment rates, low savings rates, and weaker credit growth have also hurt,” Shelly Shetty, senior director of Latin America at Fitch Ratings, wrote in a client note Oct. 27. “Lagging competitiveness owing to increased unit labor costs and difficult business environment are also hindering the recovery.”

The Marxist-leaning Rousseff tried to reinvigorate the economy by lowering taxes, boosting social programs and expanding infrastructure using public-private partnerships. Prospects for economic reforms such as reducing generous pension payouts, simplifying the complex tax system and a more business-friendly government remain uncertain as politics may continue to detract from progress, Shetty says.

In March, Standard & Poor’s cut Brazil’s sovereign debt rating to BBB minus -- one notch above junk -- and lowered its outlook from stable to negative.

“Policy drift or inadequate response leading to increased macroeconomic and financial vulnerabilities, sustained economic underperformance, and fiscal deterioration that undermines government debt dynamics and a severe deterioration in international reserves and/or government debt composition would be negative for Brazil's ratings,”  Shetty added.

Brazil’s central bank forecasts its economy will grow 0.27 percent for 2014 and 1 percent in 2015.

Low Valuations Means High Potential
Everybody’s outlook is always the worst at market bottoms. It seems people have forgotten that Brazil is getting ready to host the 2016 Olympics, which should spur an onslaught of foreign direct investments and stimulate corporate earnings and sales.

Brazil’s stock market trades a discount to both the U.S. and the global stock markets on several metrics. iShares MSCI Brazil trades at 15.6 times forward earnings vs. 17 for the SPDR S&P 500 ETF (SPY) and 16.3 for Morningstar’s World Stock category. EWZ’s price-to-book (1.7) and price-to-sales ratios are also lower than the S&P 500’s and world stocks. The S&P trades at 2.4 times book and 1.7 times sales while world stocks trade at 2 times book and 1.5 times book. At the same time, EWZ yields are larger dividend of 3.7 percent vs. 2.3 percent for the S&P and 2.5 percent for world stocks.

The total value of Brazil’s stock market as a percentage of gross domestic product is about 41 percent vs. a historical high of 108 percent before the 2008 global recession and 57 percent for its historical average, according to The law of mean reversion thereby calls for higher stock market prices.

Petrobras -- the largest-publicly traded South American oil company --  trades at 9.6 times earnings vs. the industry average of 11. Its price-to-book ratio of merely 0.5 is deep below its five-year average of 1.4 and the industry’s P/B of 1.3.  Its price-to-sales ratio of 0.6 is also deep below its five-year average of 1.2.

Petrobras shares have plunged 18 percent year to date through Oct. 27 amid falling oil prices, and Moody’s debt-rating downgrade owing to high debt levels. As of June 30, net debt came to 40 percent of net capital.

“We think an extremely negative environment is already discounted in the share price,” Bank of America Merrill Lynch research analysts Frank McGann and Vicente Falanga Neto wrote in a client note Oct. 24. “Petrobras has one of the strongest fundamental investment cases among global oils, which should continue to support further strong stock price appreciation.”

Petrobras is benefiting from “(1) strong production growth momentum, (2) additional expected announcements related to ongoing exploration work in Brazil, (3) new projects coming on stream in its international units, and (4) expected improvements in perceived country risk in Brazil,” McGann and Neto added.

Petrobras aims to cut costs by $8 billion per year over the next four years as oil production is set to increase because of new projects and improved operations in the Campos Basin, according to Morningstar analyst Allen Good. Discoveries off the Brazilian coast could triple Brazil’s total reserves. The company plans to add 1.5 barrels a day in refining capacity over the next 10 years.

“With nearly all of Brazil's refining capacity and investments to increase diesel production, Petrobras can capitalize on the growing domestic demand for refined products,” Good wrote in a note dated Oct. 24. But the investment in refineries may fail to be profitable because of cost overruns and the government-controlled prices, Good wrote.

Philip J. DeAngelo, is the owner and managing director of Focused Wealth Management, an SEC registered investment advisor, with $420 million in assets under management in Highland, NY.