Letter to Investors – 2H25
Dear Investors,
In 2025, we witnessed significant structural shifts in the global business environment, developments we had already anticipated in our previous letters. Multiple forces impacted markets simultaneously, both externally and domestically. In this letter, we outline these drivers and explain why 2026 is likely to represent a continuation of these structural trends — with one decisive event in Brazil that will shape markets and the country’s trajectory: the elections.
External Environment: Dollar, Geopolitics and Artificial Intelligence
As we have frequently highlighted in recent letters, the direction of the U.S. dollar represents the first major structural shift of 2025. The dollar interrupted a prolonged period of appreciation, effectively halting the export of inflation to the rest of the world. Economists — particularly in Brazil — tend to underestimate the currency’s impact on inflation, which can create pricing distortions for some time. The dollar’s depreciation has been unfolding since the change in U.S. administration. While there has been no formal declaration of a devaluation policy, the adopted measures and signals from key advisors point toward a shift in direction — even if, from a strictly economic standpoint, such an assumption may be debatable.
The second global inflection point is the new U.S. geopolitical stance and the cooling of the ESG agenda. The U.S. government now seeks to project strength both in trade negotiations and on the military front, advancing its agenda while containing the rise of adversaries — particularly China. In this context, Brazil gains geopolitical relevance for the U.S., given China’s significant influence in the country in recent years. The arrest of Maduro, the rightward shift in Latin American elections, and the rise of governments more aligned with the U.S. and free-market principles represent favorable tailwinds for Brazil’s upcoming presidential race. While the U.S. posture in the last Brazilian election cycle was, at best, neutral, we expect a more pronounced influence this time.
The third vector currently driving markets is the artificial intelligence (AI) revolution. Beyond its market implications — where a relatively small group of companies has captured a disproportionate share of valuation expansion, leading to increased concentration across indices and widening dispersion across sectors and geographies — the way we work has changed, the pace of transformation has accelerated, and even market dynamics themselves have evolved.
Major themes and news flow are incorporated into prices at unprecedented speed, making it increasingly challenging to distinguish durable fundamentals from shorter-term narratives. Market participants have consequently shifted toward a more tactical approach, particularly in markets such as Brazil, where the opportunity cost of maintaining longer-duration positions remains elevated.
Global Fiscal Indiscipline and the Role of AI
We have long warned that governments — both in developed economies and in Brazil — have been operating with limited fiscal discipline, and that at some point we could face a contraction in fiscal impulse, leading to weaker economic activity and lower corporate earnings. However, we see little willingness among policymakers to implement meaningful adjustments, effectively passing the problem on to future administrations. Whenever fiscal austerity is proposed, it is met with political resistance and lacks popular support.
In this environment, AI acts as a counterbalance by increasing productivity and postponing the structural adjustments that will eventually need to be made.
U.S. equity multiples remain elevated, supported by high expectations surrounding AI investments. An arms race toward AGI¹ appears to be underway: no one wants to be left behind, and few question the ultimate return on these investments. Markets are rewarding those who spend the most. In Europe, governments are increasing defense spending out of necessity, stimulating their economies through higher fiscal deficits. For 2026, we do not expect markets to penalize fiscally undisciplined governments or companies aggressively investing in AI.
Brazil: Favorable External Wave, Deteriorating Domestic Fundamentals
Within this global backdrop, Brazil benefits from an excellent external macro environment. Investors are questioning elevated U.S. valuations and policy unpredictability, increasing allocations outside the U.S. A weaker dollar improves commodity attractiveness. Aware of widespread fiscal indiscipline, markets seek protection in real assets — gold, silver and other commodities — and in commodity-producing companies as hedges against fiat currency debasement.
Domestically, however, Brazil continues to deteriorate its fundamentals at a concerning pace. On the surface, indicators appear satisfactory: inflation at 4.26% in 2025, GDP growth of 2.4%, and unemployment at historical lows. Yet we are postponing a crisis whose eventual adjustment will be difficult. Over recent years, growth has effectively been exchanged for higher debt: from 2022 to 2025, gross public debt rose from 72% to 79% of GDP. The tax burden increased to compensate for expansive and low-efficiency spending, reducing the primary deficit to below 1%, but leaving a very high nominal deficit near 9% — reflecting extraordinarily high interest rates. The recently approved tax reform, while beneficial to industry, will substantially increase the burden on service providers, resulting in a VAT rate above that of Scandinavian countries and likely reducing Brazil’s potential GDP going forward.
Given fiscal deterioration, interest rates have had to remain well above global standards to retain capital and contain currency depreciation, thereby anchoring inflation expectations.
It is crucial to understand that current Brazilian asset prices — equities, FX and rates — already embed a meaningful expectation of political change. The market prices roughly a 50% probability of government turnover. What is not priced is the continuity scenario. Should the probability of re-election increase meaningfully, the adjustment would likely be disproportionate — not a linear correction, but a step change in valuation. Global investors, in particular, underestimate the impact that governance can have. Brazil has a history of abrupt repricing when fiscal reality is finally acknowledged. We have seen similar episodes in countries such as Turkey, Argentina and, more recently, Iran, whose currency depreciated 80% over 12 months. Downside tail risk is far greater than consensus assumes.
Positive Asymmetry: The Change Scenario
Conversely, a change in government would likely be highly supportive for markets. Brazil could capitalize on the favorable global backdrop and, with renewed investor confidence, establish a virtuous cycle of fiscal adjustment, falling interest rates and rapid asset repricing — a process already underway since 2025.
With prospects for lower rates, modest growth (given necessary adjustments), and a benign external environment, there is substantial value to be captured in equities and fixed income.
Brazilian equities currently trade, in our view, at approximately 9x 2026 earnings. Excluding commodity producers — whose dynamics are more globally driven — domestic companies trade below 10x earnings, compared to historical levels above 13x. Equity allocations remain at depressed levels, and we are already observing early signs of renewed inflows following the Central Bank’s signaling toward rate cuts. As monetary easing deepens, a significant amount of capital currently allocated to tax-advantaged fixed income — which has materially impaired equity valuations — should migrate toward risk assets.
2026 Elections: The Decisive Catalyst
For 2026, from a market perspective, a single factor will drive expectations from euphoria to distress: the elections. The market currently assigns roughly a 50% probability to either outcome — re-election or political turnover. We believe the asymmetry is positive and that the probability of re-election is remote, for several reasons.
First, the current administration was elected in 2022 against an incumbent with even higher rejection rates. Today, President Lula holds the highest rejection rate among leading politicians, despite superficially favorable economic indicators — a situation analogous to the Biden administration in the U.S. Key voter concerns — public security and corruption — are particularly challenging themes for left-leaning parties during electoral cycles.
All governors in Brazil’s South and Southeast regions are from the opposition and enjoy high approval ratings, led by Tarcísio de Freitas in São Paulo, who would likely prevail in the country’s most decisive state. Centrist parties, particularly PSD — which has gained significant political strength — are unlikely to align with the PT, given their leadership’s historical positioning and participation in São Paulo’s state government.
The PT’s performance in the Northeast continues to deteriorate. What was once a stronghold now faces significant headwinds in two of its three largest states — Ceará and Bahia — where PT-backed gubernatorial candidates are not currently leading. In Minas Gerais, another critical electoral state, Governor Romeu Zema is frequently mentioned as a potential vice-presidential candidate and maintains strong approval ratings, while the PT lacks a competitive state-level candidate. Notably, in the most recent municipal elections, center-right parties secured approximately 70% of total votes versus 30% for the left, with the PT winning only one state capital — Fortaleza — by a narrow margin.
Therefore, markets appropriately assign a meaningful probability to political turnover. This scenario should crystallize throughout the year, with significant volatility. By the end of the first quarter, the picture should be clearer — or even effectively defined from a market standpoint, should Lula decline to run or his probability fall below 40% in prediction markets. The adjustment, if it comes, will likely be swift and sharp, consistent with recent market dynamics.
Risks to Monitor
Key risks to our constructive scenario include:
(i) reversal of electoral expectations, increasing the likelihood of policy continuity with limited fiscal discipline;
(ii) deterioration in the external environment, including a global slowdown and falling commodity prices;
(iii) institutional setbacks that raise Brazil’s risk premium.
We remain attentive to these evolving factors.
Conclusion
In summary, Brazil is walking on thin ice, with a wide spectrum of potential outcomes — making markets more volatile, but not less opportunistic. The financial relief from the expected decline in interest rates is meaningful. Still, we depend on a non-adverse external environment and an electoral outcome that addresses fiscal imbalances.
With a favorable global backdrop, prospects for monetary easing, and a meaningful probability of political change, there is significant room for asset repricing, particularly through multiple expansion. Earnings growth should primarily stem from financial relief and from companies gaining market share and competitive strength — rather than from broad economic acceleration, which is likely to moderate in the coming quarters.
Sincerely,
Moat Capital
¹ Artificial General Intelligence (AGI) refers to AI systems capable of understanding, learning and performing any intellectual task that a human being can perform.