One of the nice things about interviewing over 500 thought leaders in the realm of investing and finance on my podcast Lead-Lag Live is getting exposure to new investment ideas and tracking really smart people’s arguments for where to turn attention to next. On X, Tavi Costa, who I had on not too long ago, showed an interesting chart of the MSCI Brazil index. He argued that it makes no sense to buy Magnificent 7 stocks with insane valuations when there are stocks in Brazil that trade at 5 times earnings and are clearly tied to the commodity cycle.
Tavi is fundamentally right.
Brazil IS cheap and is a comparatively more stable part of the emerging market space. Brazilian stocks and ETFs like the MSCI Brazil ETF (NYSEARCA:EWZ) have gone nowhere for well over a decade. Oddly enough, I like that. I believe in mean reversion and cycles. I believe valuations do matter in the very long term. And that’s why I believe Brazil may actually be a really good place to allocate to right now.
Using EWZ’s portfolio as a proxy for Brazil’s market, we can clearly see that it’s heavily exposed to the commodities sector, with materials and energy making up more than a third of its portfolio. The ETF’s largest holdings include Petrobras (NYSE:PBR), Vale (NYSE:VALE) and Ambev (NYSE:ABEV). Investing in Brazil isn’t some tech play. It’s a commodity and value play.
It’s also apparently a high dividend play, with many of these stocks yielding around 8%. When you combine high dividends with low valuation, what’s not to like? Even on a forward P/E basis, Brazil continues to look undervalued. The forward P/E ratio for the MSCI Brazil index currently stands at 8.3x, making it an intriguing option for value investors in the long run.
It’s more than that though. The Brazilian central bank’s monetary policy and its decisions on interest rates significantly impact the Brazilian stock market. Historically, a decline in interest rates has correlated positively with the performance of Brazilian equities. And that central bank is in a cutting rate cycle now, way before the Federal Reserve here in the U.S.
The Bottom Line on Brazilian Stocks
Yes, I know Brazil is volatile. Yes, I know it has currency risk (and that by the way is important to emphasize). The Brazilian real has historically depreciated against stronger currencies like the U.S. dollar, euro, and the pound. This depreciation can impact the returns for investors who live and spend in these stronger currencies. But that can be hedged, and if the dollar were to fall, unhedged exposure to Brazil becomes even more interesting.
Momentum may not be fully there, but I really do think Brazil is worth keeping an eye on. Valuations should matter again and it’s only a matter of time until the investor love affair with U.S. tech ends. This would favor emerging markets like Brazil, and cheap commodity-linked plays.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
