Supporters of Brazilian right-wing presidential candidate Jair Bolsonaro take part in a rally in Sao Paulo, Brazil on September 09, 2018. Cris Faga | NurPhoto | Getty Images

Investors in Brazilian stocks should buckle up for more volatility as the country's upcoming presidential election approaches. Jair Bolsonaro, the far-right candidate leading the polls ahead of the Oct. 7 first round, was nearly stabbed to death earlier this month. Bolsonaro got a boost in the latest polls after the stabbing but is largely expected to lose in a runoff given how polarizing a figure he is. The election's uncertainty — along with a massive sell-off in emerging markets — dragged Brazilian stocks lower this year. The exchange-traded fund that tracks Brazilian shares fell into bear-market territory earlier this year. The road could get even bumpier for investors in the next few weeks as the contest draws near with no clear-cut favorite to win. "The outcome will be very important from a macro perspective because it will determine the policy path moving forward," said Alberto Ramos, head of Latin American economics at Goldman Sachs. "The market would like to see a market-friendly candidate win, but that's more of a dream than reality." Brazil's presidential election features five candidates with a chance to win, including Bolsonaro of the Social Liberal Party, Ciro Gomes of the Democratic Labor Party, Geraldo Alckmin of the Brazilian Social Democratic Party and Fernando Haddad of the Workers' Party, who is replacing imprisoned former President Luiz Inacio Lula da Silva.

The challenge I see for Bolsonaro is … he still has a very high rejection rate. A lot of people wouldn't vote for him in any scenario. Paulo Gregoire Latin America analyst at Stratfor

Bolsonaro, a former army captain championing a tough-on-crime stance, is polling at 28.2 percent, according to a survey released on Monday by pollster MDA. Haddad, the former mayor of Sao Paulo, was polling at 17.6 percent. Leftist candidate Gomes, meanwhile, was polling at 10.8 percent, while business-friendly Alckmin was at 6.1 percent. "This is the most unpredictable election in Brazil since 1989" because of how close it is, said Paulo Gregoire, a Latin America analyst at Stratfor. Fernando Collor de Mello defeated Lula in a runoff by just 0.6 percent of the total vote in 1989. Gregoire noted that growing frustration with the political establishment in Brazil "has opened up the door for other candidates to run," making the race closer than normal. Bolsonaro jumped into the lead after a Brazilian court ruled that Lula, the country's most popular politician, could not run for the presidency once again. Lula is serving a 12-year sentence for corruption. The former president is the highest-profile casualty of Operation Car Wash, a sweeping corruption probe that has rattled Brazil's political establishment since 2014. However, the election is expected to go into a second-round runoff as no candidate is expected to garner more than 50 percent of the vote. This presents a problem for Bolsonaro since many expect him to lose in a runoff. "The challenge I see for Bolsonaro is … he still has a very high rejection rate," Stratfor's Gregoire said. "A lot of people wouldn't vote for him in any scenario."

Pension reform a political sticking point

Bolsonaro has been criticized for making homophobic and racist remarks. In 2011, he told Playboy he would rather have a dead son than a gay son. He also said in another interview that Haitian immigrants were bringing diseases to Brazil. These types of comments not only narrow Bolsonaro's path to the presidency, but they also limit the political capital he would need to move forward with key economic policies, specifically pension reform.

The beef with Bolsonaro is not economic. The beef with Bolsonaro is his capacity to deliver. He is such a polarizing figure; nobody would want to work with him. Alberto Ramos head of Latin American Economics at Goldman Sachs

Current President Michel Temer pushed to reform Brazil's pension system but failed, as his proposed measures were widely unpopular. The country's pension system was a contributing factor in Brazil's deficit rising to 10 percent of GDP in 2015. The Brazilian system is an outlier compared to pension schemes in other countries. While most public pensions include a minimum retirement age, the Brazilian system pays high replacement rates — the percentage of a worker's pre-retirement income ultimately paid out by a pension program — and does so at a much lower age. As a result, under the current rules, pension spending could reach as high as 17 percent of GDP by 2060, according to a recent study by the Organization for Economic Cooperation and Development. The population ages 65 and above will more than triple within the next four decades, increasing to 38 percent by 2050 from about 7.6 percent of the population in 2010. "If you don't do pension reform, you won't be able to take on other policy measures; that's a precondition," said Ramos of Goldman Sachs. "Otherwise, the country will be ungovernable." Ramos noted, however, that a Bolsonaro victory makes it more unlikely that such policies will be implemented. "The beef with Bolsonaro is not economic. The beef with Bolsonaro is his capacity to deliver" on key economic policies, Ramos said. "He is such a polarizing figure; nobody would want to work with him." The other candidates, however, would also struggle to move forward with pension reform or are unwilling to push through with such measures, and that scares investors who have ridden out a recently volatile Brazilian economy. "Even a market-friendly president won't be able to stabilise the public finances and boost potential growth significantly," William Jackson, chief emerging markets economist at Capital Economics, wrote in a note earlier this week. "Markets don't appear to be pricing in this risk in full."

Election fears hit Brazilian shares and currency

Shares in Brazil had a strong runup to 2018. Between 2016 and 2017, the Bovespa index surged 65.8 percent while the iShares MSCI Brazil exchange-traded fund, EWZ, skyrocketed 82.6 percent. This year, however, has been much tougher for Brazilian shares. The ETF has fallen more than 20 percent in 2018, tracking for its worst year since 2015. The fund is also in a bear market, down 35 percent from its 52-week high. Last month, investors pulled money from the ETF at the fastest pace on record, with more than $750 million in outflows. Bovespa, meanwhile, is up just 0.5 percent this year, compared to the 's 8 percent gain. The Brazilian benchmark index has fallen more than 10 percent since early May and is among the worst performers in the world. Brazil vs US equities in the past year The sell-off in Brazilian assets has intensified in recent weeks as new polls have spotlighted waning support for centrist, market-friendly candidates, including Alckmin of the Brazilian Social Democratic Party. Bovespa dropped 2.3 percent last Tuesday after a poll revealed growing support for leftist candidates Gomes and Haddad, a sign the election could turn out to be a showdown between two extremes of Brazilian politics. Meanwhile, the Brazilian real has also come under renewed pressure this past week. The currency hit its lowest level since 2015 against the U.S. dollar in late August. "Evidence from the elections of other populists in the emerging world over the past decade ... suggests that, as political risk gets factored in, the real could weaken by another 5 percent against the dollar," Jackson of Capital Economics said. The real is the third-worst-performing emerging-market currency against the dollar this year, after the Turkish lira and Argentine peso. "There's mass frustration among the international investment community about Brazil," said Daniel Osorio, president at Andean Capital Advisors. "Brazil has been on the verge of becoming the economic and political superpower of Latin America, but it's been on the verge for the better part of 50 years."

Economic recovery continues to be a struggle

Brazil continues to struggle to recover from its worst recession on record. Unemployment remains in double digits and public debt has risen sharply to 74 percent of GDP, up from just over 50 percent at the start of the decade. The country's economy has also flashed warning signs of more trouble ahead. In the previous quarter, the Brazilian economy grew slower than economists had hoped, hampered by a nationwide trucking strike in May that resulted in widespread product shortages. In light of the weak economic figures, Brazil's central bank reduced its full-year forecast for economic growth in June to 1.6 percent from 2.6 percent.