International stocks have delivered outstanding returns in the past year, but you couldn’t tell by looking at Brazil. Even as the MSCI World Index has produced a one-year return of 10.7% and the iShares MSCI Emerging Markets Index Fund (NYSE:EEM) has managed a gain of 3.6%, the iShares MSCI Brazil (Free) Index Fund (NYSE:EWZ) has saddled investors with a loss of nearly 10%.
And not without good reason: Because of its dependence on commodity exports, Brazil has been hit hard by the economic slowdown in other parts of the world.
According to JPMorgan, a full 23.7% of Brazil’s exports go to Europe — more than any other country in Latin America. Another 16.9% get shipped to China, which puts Brazil second only to resource-rich Chile. That’s a total of 40.6% of exports headed to two of the world’s (currently) most troubled economies. The result: While the consensus estimate for Brazil’s economic growth for 2012 was 3.5% at the start of the year, analysts are now looking for just 1.9%.
For Brazil’s stock market, this has been a recipe for disaster.
The silver lining is that all of this bad news might present an opportunity for investors who are willing to go against the grain. Four factors indicate that Brazilian equities might become more attractive as we move into 2013:
- The sentiment regarding China’s growth outlook remains very negative, yet recent economic data indicates that the economy has begun to stabilize. And even though growth is slowing, China still is on track for growth of 5% to 7% — far better than the developed world. Once the decline stops and growth numbers steady in this range, it will remove a great deal of pressure from the types of natural-resource stocks that make up such a large part of Brazil’s stock market.
- The Brazilian government has been active in providing fiscal stimulus, enacting no fewer than 19 targeted programs in the first nine months of the year, according to JPMorgan. The real stimulus may be yet to come, however: The 2014 World Cup is leading to US$42 billion of infrastructure investment around the country, while the 2016 Olympics in Rio de Janeiro are expected to result in another US$14 billion of investment.
- Brazil’s central bank has cut interest rates aggressively in response to the slowdown. The SELIC rate (the equivalent of the fed funds rate) has dropped to 7% — its lowest level in history — and with inflation at 5.5%, real interest rates stand at just 1.5%. For Brazil, this is an exceptionally low level. In conjunction with the economic stimulus measures, these low rates might already be having an impact based on better-than-expected third-quarter GDP growth.
- While Latin America as a whole is trading in line with its five-year valuation, Brazil is trading at a discount. This is a function of the country’s weaker growth outlook, but it also indicates that this is already discounted into market prices.
How to Play Brazil
For investors who want to take the broad-based approach, EWZ is the largest and most liquid ETF that invests in Brazil. However, there’s also some concentration risk here: Nearly 28% of the fund is invested in the common and preferred shares of Petrobras (NYSE:PBR) and the iron-ore producer Vale (NYSE:VALE). On the plus side, the fund offers a yield of approximately 2.8%.
Those who are looking to invest in Brazil while minimizing the impact of global economic risk can consider Global X Brazil Consumer ETF (NYSE:BRAQ), which narrows the Brazil bet down to the domestic consumption story. The ETF has gained 18.4% in the past year — much better than the broader market — but its trading volume is extremely low. Investors with higher risk tolerance also have the option of the ADRs of domestic-focused stocks, such as Ambev (NYSE:ABV), BRF-Brazil Foods (NYSE:BRFS) or Wal-Mart de Mexico (PINK:WMMVY).
The Bottom Line
Buying into Brazil isn’t an easy investment to make. The volatility and headline risks are high, and the impact of external factors such as China’s slowing growth makes this a messy story. But for investors with a longer-term time horizon, Brazilian equities might be one of the best value plays in the market today.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.