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3 Big-Name Bargains in Brazil

Emerging market investors can find opportunity in oil, bank and utility stocks

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In the first quarter, the Brazilian MSCI Index — a better benchmark for foreign investors than the local Bovespa index — was up just 2%. That compares with a total return of 5.9% for the S&P 500. So why has the Brazilian market underperformed in the first quarter, and is there an opportunity here in this promising emerging market?

Well, one quarter’s worth of performance doesn’t make a long-term trend, and while the Brazilian central bank is tightening monetary policy, the Federal Reserve is still doing the opposite. The Brazil economy is growing at a 7.5% annual rate, faster than the rate just before the 2008 financial crisis erupted. The short-term central bank (SELIC) rate is at 11.75% — possibly going higher — as it is a little lower than at the time of the 2008 crisis.

The Brazilian central bank is also hiking reserve requirements in order to drain liquidity from the money markets, while the Brazilian finance ministry is imposing taxes on short-term money flows into the country aimed at reducing carry trades that are capitalizing on the interest rate differences between the 11.75% SELIC rate and the 0.25% Fed funds rate.

But the money keeps flowing and, according to Bloomberg: “Brazil received net inflows of $10.5 billion from trade and financial investments from March 1 to March 25, compared with $7.4 billion for all of February, according to the central bank. This year to date, inflows totaled $33.45 billion, compared with $24.35 billion for the whole of 2010.”

So I think that the Brazilian authorities may have managed to make the local market underperform the S&P 500 for the first quarter, and they might manage to do it for another quarter or so, but it is very unlikely that Brazilian equities will continue to do so for the whole year and beyond.

This is because of surging commodity prices, most particularly oil, and the strength in Brazilian consumer spending, as well as the positive political climate created by the smooth transition from President Lula da Silva to President Dilma Rousseff.

2010 Laggard is a 2011 Leader

To play oil in Brazil you have to be a buyer of Petrobras (NYSE: PBR), which was a huge laggard in 2010 compared to the otherwise strong global energy sector. The maneuvering for the multi-layer $224 billion financing kept a lid on the stock, but there is now some clarity being introduced into the situation, and the stock is beginning to move higher.

The conflicts across the Middle East sent oil prices above $100 a barrel. Crude averaged about $81 a barrel from the start of the year through mid-February, but has surged 25% since then, and with the situation in Libya, we may likely see a triple-digit average price in 2011.

As a result of the combination of surging emerging market demand and constrained supply leading to higher prices, Petrobras may play catch-up with the rest of the global energy sector in 2011, considering that Petrobras based its $224 billion investment plan for 2010 to 2014 on an average oil price of $80 a barrel.

With the stock having the largest weighting in the Brazil MSCI Index, strong performance in 2011 after underperforming in 2010 will spring-load the broader index as oil prices surge.

Article printed from InvestorPlace Media,

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