Increased risk perception. Recent macro and microeconomic decisions are curbing the
visibility of investors. On the macro front, concerns are on the 50bp BCB cut on the Selic
while the Focus survey points to 5.5% inflation in 2012. On the micro front, measures
such as the IOF tax on FX derivatives, the revision of the mining code, and the new tax on
imported cars add a new layer of uncertainty to valuations.

Brazilian equities are cheap and will remain there. Brazil is now trading at an 8.3x PE ratio, which is an 18% discount to its past 3-year multiple and a 10% discount to GEMs. Compared to local rates, one can find equities at a 21% discount to fair value. This is due to increased risk perception and it will remain so until inflation expectations are well-anchored and the micro policy noise diminishes.

Buy inflation. Investors should buy stocks that provide insulation from rising inflation. We are still believers in growth, but now prefer plays with lower risk.

Sector shifts: replacing consumer and retail with acquirers and malls. We like the acquirers and malls as plays in the domestic economy that offer a diversified revenue base, inflation protection, and either credit growth (in the case of acquirers) or hard assets (malls). We prefer to stay out of consumer and retail names.

Mind the BRL devaluation. The risks for a BRL depreciation have increased and this may catch investors short as this theme has been off the radar screen since early-2003 (except for a short period during the 2008 crisis). Investors may consider currency hedge as they put their money into Brazil.

Takeaway: Brazil equities are cheap (see chart below) and EPS expectations are low, but the global market risks are still high, the BRL is volatile, and the country needs to sort out inflation. It can get even cheaper in the short term. Consider Banco Itau Unibanco (ITUB). Stay away from commodity plays like Petrobras (PBR) and VALE. Shorting EWZ could also be a good speculative hedge.

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