Is There Any Samba Left In Brazil's Stocks?

By Aaron Levitt | May 28, 2014 AAA

The emerging market economies known as the BRICs haven’t exactly lived up to their hype lately. It’s been slow going for Brazil, Russia, India and China, as evident in the poor returns for ETFs such as the SPDR S&P BRIC 40 (BIK) in recent years.

Brazil, in particular, has frustrated investors. With a coming World Cup and a new, huge and largely untapped source of oil off the coast, one would expect "Ordem E Progresso" (order and progress – Brazil's motto) to continue for a while longer.

But past growth only served to hide – rather than solve – Brazil's structural problems; it still over-taxes, over-borrows and under-invests. Those issues, combined with political fecklessness, have caused Brazil's economy to stagnate and the country's equities to stall. That’s left many investors scratching their heads and abandoning Brazil. That might be premature, though, as there are still plenty of reasons to be long the South American giant. In fact, today's sluggish conditions could equate to a great buying opportunity. (For more on this topic, see Investing In Brazil 101)

Issues, But Still Promise

With its rich natural resources, a young, increasingly wealthy demographic and conservative financial picture, Brazil had established itself as one of the planet's economic powerhouses. After a key election in 2002, Brazil underwent a wave of pro-market reforms. These factors helped push Brazil’s GDP up an average of 3.6% a year from 2001 to 2008. From 2004 to 2008, Brazilian stocks surged 350%. That robust growth has slowed over the past two years to an average of 1.7% per year.

The key issue has been inflation. Consumer prices rose more than 6% this past March – the biggest gain in nearly eight months. That high inflation rate has helped cripple Brazil’s consumer economy, which has been one of its main driving forces. To combat the high inflationary rate, the Brazilian central bank has been forced to embark on a series of interest rate hikes, brining the interest rate in the nation up to 11%. Needless to say, that’s hurt economic growth and raised costs for businesses.

Yet, there are some glimmers of hope.

The poor economic situation has many analysts believing that current populist President Dilma Rousseff will not be re-elected in the next general election in October. Her ouster should usher in a series of needed structural reforms, which should help the economy grow faster. The Latin American giant is still blessed with a huge consumer class, vast mineral and energy resources and relatively stable credit market, so its outlook remains rosy.

Add in that Brazilian equities can be had for a price-to-earnings metric of just 14 and the longer term bargain begins to emerge.

An Entry Point?

All in all, various reforms and measures should invigorate Brazil's long-term upward swing. For investors, the current depressed state of its markets could be just the entry point they need to add the nation to a portfolio. The easiest way to add some samba is through the iShares MSCI Brazil Capped ETF (EWZ).

With nearly $4.5 billion in assets, EWZ is the largest ETF in the pace. Currently, the fund tracks 77 different large-cap Brazilian equities, including oil & gas powerhouse Petrobras (PBR) and utility CPFL Energia S.A. (CPL). So far this year, returns for the ETF have been poor. EWZ has sagged 12.4% this year, making it quite the bargain. The First Trust Brazil AlphaDEX Fund (FBZ) can also be used to target the nation’s large caps. (For more on this topic, see Investing In Brazil Through ETFs)

With a population of 215 million, the consumer story in Brazil continues to be a driving force. As inflationary pressures dwindle, these consumers will increase their spending. That makes both the Global X Brazil Consumer ETF (BRAQ) and Market Vectors Brazil Small-Cap ETF (BRF) potential buys. BRAQ tracks 37 consumer-specific stocks and BRF tracks 76 Brazilian small-caps. Most of BRF’s holdings are in the consumer and financial sectors. Both ETFs target the growing local economy of the Latin American giant and its middle class.

Finally, while the build-up to the World Cup is almost completed, Brazil is has plenty of work to be done on the infrastructure front. The World Economic Forum's latest Global Competitiveness Report ranks the nation low in terms of infrastructure. The EGShares Brazil Infrastructure ETF (BRXX) allows investors to access the build-up, while Brazilian steel firms like Companhia Siderúrgica Nacional (SID) and Gerdau S.A. (GGB) continue to see local sales grow.

The Bottom Line

While it hasn’t lived up to its promise as of late, Brazil’s longer term picture is still rosy. And given its recent underperformance, now could be a perfect time to strike.

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