At 9:10 p.m. Brasília time last night, Brazil’s electoral court called the race for Lula.

Within minutes, the iShares MSCI Brazil ETF (EWZ) fell off a cliff. By Monday premarket, it was down 25% at $30.99. Petrobras (PBR) fell 23% to $20.05. The real, which strengthened to 4.97 per dollar on Friday as traders bet on Bolsonaro, now trades at 5.25.

Flávio Bolsonaro refused to concede. He wants the election annulled.

Three weeks ago, he led the first round by 2.2 million votes. On Sunday, he lost the runoff by 4.3 million. No Brazilian candidate had lost round one and won round two since 1989. At 80 years old, Lula just did it.

What do you do with a market that gave back a quarter of its value before the opening bell?

Swamp Things Meddling…

Lula didn’t win on his record, that’s for sure. He won the sovereignty vote.

Over the past 15 months, DC slapped 50% tariffs on Brazilian goods, then watered them down, then hit certain exports with new 25% tariffs this summer. It sanctioned Supreme Court Justice Alexandre de Moraes over the jailing of Jair Bolsonaro, then quietly dropped him from the list in December. It pulled the visas of eight justices.

On Saturday, Reuters reported that two State Department appointees, Darren Beattie and Ricardo Pita, had told US diplomats in Brazil that restoring Jair Bolsonaro was American policy. After Jair got 27 years, they switched to Flávio and told embassy staff to ignore other conservatives. Brazil barred Beattie from entering the country in March.

One US official quit over it, saying the line between diplomacy and intervention had been crossed. I can’t decide whether this career official had an ostrich-like level of ignorance or an attack of conscience. I’ll go with the former, as I never assume any bureaucrats have a conscience.

Lula took every one of those moves and hung it around Flávio’s neck. He called Flávio “Trump’s candidate.” He said The Swamp wanted to “colonize” Brazil, which, oddly enough, had credence considering what happened in Venezuela.

One analyst joked that Donald Trump was Lula’s best campaigner. Many a true thing is said in jest, the old saying goes.

Holding together a thin coalition is cheaper with a foreign threat than domestic promises. The promises come due, while the threat may never materialize.

The Donald handed Lula his get-out-of-jail-free card, free of charge. It’s amazing - or not - how these things blow up in DC’s face with great regularity.

About That Cheating…

Flávio alleges that the Supreme Court’s two-hour voting extension favored Lula, and that his party’s inspectors were removed from a secure room during the count.

Also on the record: Lula’s campaign reported suspended public transit in several key areas, which is why the court extended the hours. Agência Brasil, the state news agency, reported that both campaigns asked for more time.

Politics are filthy, especially in socialist democracies, but I repeat myself.

Still, that doesn’t change the facts that the vote was close, the referee was compromised, and the challenge runs through the same court that called the result.

I wouldn’t bet on an annulment. But there will be weeks of headline risk to trade off it, if you fancy it.

The Numbers Under the Hood

Like most socialists with a central bank at their beck and call, Lula isn’t strong at the math.

Brazil’s nominal deficit runs near 10% of GDP. Inflation sits at 4.6% against a 3% target. Growth limps on at under 2%. Gross debt is 83% of GDP and heading north. The Selic rate (the Brazilian equivalent of the Fed Funds rate) sits at 13.75%, with a real rate near 9%, among the highest in the world. Like the US, Brazil’s interest bill is eating its budget.

And like his American compatriots, Lula still wants to spend. Congress, where Bolsonaro’s party now holds the most seats in decades, wants to stop him. The likely outcome is gridlock, which is what the bond market wants because then no one will have the keys to the printing press.

The Brazilian real is trading at 5.25 right now, a massive drop from 4.96 on Friday.

USD is the base currency in the USDBRL pair, so it now takes 5.25 reais to buy 1 USD, up from last week. Since the dollar is more valuable, the real has weakened.

A weaker currency lifts inflation, which keeps the Selic high, which keeps the deficit wide. That vicious cycle is why EWZ’s chart is down 25% when the other fundamentals didn’t move.

Watching a major currency lose over 5% overnight on a vote count reminds you that money is a political weapon before it’s anything else. The Man Himself, Jim Rickards, wrote the book on that. Currency Wars came out in 2011, and reads like it was written last week. Jim is giving away a free physical copy, no credit card requested or required, to anyone who watches his new dollar briefing. If you want to understand what Brasília, Beijing, and DC are all doing with their currencies right now, start there.You can get your copy here.

Two Charts

EWZ closed at $38.19 on October 2, the Friday before round one. It jumped 12.5% to $42.98 on Flávio’s lead and closed last Friday at $42.59.

Sunday night wiped out that premium and took another 10% off. Monday’s premarket print of $30.99 went further. The daily chart is flat-out broken. EWZ is sitting on the 200-week moving average at $31.04.

EWZ’s daily chart. Credit: TradingView

In plain English: the market didn’t just remove the Bolsonaro premium. It went back below EWZ’s summer lows, before anyone thought Flávio could win. That’s a sentiment print, which may portend a rebound. The chart better hope so.

Petrobras is the same story. PBR closed Friday at $26.16, a 52-week high, after a 25% run in October alone. The premarket print of $20.05 is back below the old $22.24 high, closing a gap in the chart, and then some. The chart below shows what happens to this stock when Brasília runs it for politics.

PBR’s daily chart. Credit: TradingView

The good news is that Petrobras trades at about 4x earnings and yields 7% to 8%. It just posted a record quarterly profit and pumped 2.7 million barrels a day, beating its own target. Its five-year plan promises $45 billion to $50 billion in dividends.

The bad news is the government owns 50.26% of the voting shares. Lula calls Petrobras his “development engine.” In SocialistSpeak, that means “milking cow.” The first time we saw this movie, it ended in early 2016 with the stock at $2.71.

A weaker real helps PBR. It earns dollars and pays costs in reais.

Governance is the key risk here, as it is with all socialist-owned enterprises.

Wrap Up

All this said, I’m not buying EWZ today. It’s resting on the 200-week average at $31. If that breaks, $28.42 is next. Flávio’s annulment fight will launch weeks of headlines, each one a chance to buy at a discount.

PBR, which I own, is tough. If you don’t own it, but are considering it, I’d wait. As for me, the chart is ugly. If it doesn’t immediately rebound, I’ll be a seller. While I love its long-term prospects, I have no interest in waiting around while the rest of the energy complex takes off.

As for The Swamp’s machinations, the Reuters story on Beattie and Pita is worth ten minutes of your time. Read it and decide whether any of it bought a single vote.

The market will pay you to be patient… and punish you if you’re too early.

Have a great day ahead.