Why We're Enthusiastic About Brazil

While China and India get the bulk of attention as B.R.I.C. nations (NYSEArca: BIK), it's Brazil that has shown the most promise. Through the March 24th market close, the iShares MSCI Brazil fund (NYSEArca: EWZ) has climbed roughly 15%. We are enthusiastic with Brazil's multi-faceted potential.

While chasing returns is not a promising strategy, examining Brazil’s larger macro picture is encouraging.

Brazil stands to emerge from the global downturn in a stronger position than much of the developed world. Here is our reasoning; Inflationary pressures are to Brazil’s advantage. The talk of inflation, a weak U.S. dollar and slowly rising oil prices boost the demand for and value of Brazil’s resources. Materials, energy and agriculture comprise approximately 50% of EWZ's holdings and roughly 21% of Brazil’s exports. Then too, there's the eventual impact of stabilization in world economies.

As the global economy regains its footing and existing energy exploration projects are put on hold, we expect to see inflationary pressures pushing oil and materials prices higher. In this environment Brazil is well positioned to benefit from such increases.

Banking on Oil and Banks

The somewhat recent discovery of the Tupi oil field is touted as the biggest since Kazakhstan in 2000 and the largest deep water discovery thus far. With Petrobras (NYSE: PZE), a state-owned enterprise and a foreign-friendly business environment, Brazil is genuinely more capable of efficient and productive extraction than many of its neighbors.

Bank strengths, interest rates and room to cut Brazil’s central bank rate remains high, above 11%. However, the Central Bank still has significant room for reduction. Inadequate credit may cap domestic inflation pressures to some extent, enabling the rate to revert to lower levels. While Brazil is unlikely to match Western level interest rates, there is room for rapid cuts such as those seen on March 11, when rates were slashed by 1.5%.

As in other regions, Brazilian bank lending has slowed, yet it has some of the most well capitalized banks in the world. They were helped by massive inflows of commodity dollars and enormous bank spreads. Thankfully, the banks did not need to take excessive risks through structured debt as they were already profitable. Heightened bank regulation stemming from the mid-90’s inflation crisis also contributed to this result.

Food for Thought

Agribusiness and food prices are favorable.

According to Potash (NYSE: POT), the global agribusiness firm, Brazil remains headed for a continuation of steady agricultural growth by late 2009 and 2010. The reduction in the global value of the Real, Brazil's currency, has increased profitability for farmers selling abroad and will likely continue in their favor. Higher oil prices and steady emerging market food demand, thanks to China (NYSEArca: FXI), their second largest trading partner, continue to support Brazil’s agricultural markets and prices.

Although world food prices are off their highs, they remain nearly 30%-50% above their decade averages. Agriculture comprises approximately 8% of the nation’s GDP and employs nearly one-fifth of the nation’s workforce.

Public Spending Growth as Election approaches: 2010 is an election year and Brazil continues to have a large, albeit declining, debt surplus. Traditionally public spending increases in election years. We expect social programs and infrastructure improvement to benefit

Final Thoughts

Even with the bright outlook indicated above, nothing is perfect. Undoubtedly, Brazil’s exports will slow, specifically transport equipment, their largest export (12.5% of exports in 2007). Politics is another consideration.

Social angst may make it more difficult for the existing ruling party to stay in power. President Lula da Silva who has been a strong force behind a developing Brazil, will be replaced when he completes his maximum allowable term. GDP estimates are wide, with private estimates showing a slight potential contraction. Nevertheless, increased state bank lending and monetary easing will likely mitigate this trend.

Overall, our research at ETFdesk.com shows EWZ moving higher, as Brazil becomes a more advanced and a resilient developing economy.

Disclosure: none

Comments

[rickf:]

PZE is the smaller subsidiary of Petrobras, I think.

PBR and PBR/A are the "mother" company.

(Disclosure: Long PBR/A)

Mar 27 07:55 AM

[robert99:]

I'm hoping for another sell off so I can pick up a substantial position in EWZ.

Mar 27 08:28 AM

[Chris B:]

I was fortunate to have limit buy orders in place on EWZ that were triggered a couple weeks ago. Unfortunately, I missed the bottom on EWA by a penny using the same strategy! Doh!

EWZ is an amazing value right now. The same money managers who were plowing money into communist China 2 years ago at PE's over 20 are now ignoring capitalist Brazil at PE's of less than 8! Go figure.

Many of them dismiss Brazil as a commodity country, but EWZ is 18% financial services. This might be where the real appreciation potential lies if the US has actually blown its lead in the financial industry and the Euro becomes a deflationary hole.

Mar 27 10:04 AM

[Mad Hedge F...:]

So am I! The one screaming buy out there now are the emerging markets. The US, Europe, and Japan are now committed to spending trillions of dollars to shock the global economy back to life. This is costing the emerging economies nothing, and gives them a free ride back to prosperity. IT turns out that the smaller economies are financially better off than the big ones, with a decade long export boom blessing them with massive foreign exchange reserves and little debt. China, Russia, India, Brazil, and Turkey will be the big beneficiaries. You can buy the specific ETF’s for these countries, or go with the generic iShares MSCI Emerging Market ETF (EEM), which has already started to outperform US markets in a big way. It’s a once in a century opportunity to buy the highest growth corners of the world’s economy at severely knocked down prices.

Mar 27 11:25 AM

[nun:]

I'm not sure why, but PZE is almost ALWAYS mentioned in articles like this, when the bigger factor is really PBR. Are you guys all using the same (wrong) ticker lookup software?

Mar 27 12:10 PM

[JKA:]

Nun is right. How can an anylyst mistake PBR for PZE.?
PZE is mostly Argentina based.
Huge difference - watch out!

Mar 27 09:08 PM

[Drew R:]

It also appears that Brazil has relatively strong institutions. Their left of center president has not tried to nationalize everything in sight like some of the others. Of course, this country will be a good natural resource play once the inflation picks up.

Mar 27 11:47 PM

[Kunst:]

I'm guessing that the author is not the one who put in the PZE symbol.

Mar 28 01:17 AM

[nmelendez:]

PZE is the Argentine based company who's parent is PBR. He is wrong in calling PBR PZE. PZE however has a nice growth and P/E. They are also producers of nat gas ant petro based oils plus gas station owners, kinda like mobile

Mar 29 12:04 AM

[Rodrigo:]

I would also add the opportunity to bet on the Brazilian currency and lower interest rates. Real-denominated international bonds seem to represent an interesting diversification and theme play.

Apr 14 07:50 AM

[Mad Hedge F...:]

xgt Hoping to beat the rush, I ordered my Rosetta Stone Portuguese language program last week, fully expecting Rio de Janeiro to win the 2016 Olympics bid. Pick pockets of the favellas of Latin America’s largest city were ebullient. A cheer even went up on the floor of Chicago’s CME, now that the denizens of the Windy City are dodging a monster tax bill. Of course, Obama was in a no win situation, with mud on his face for his failed pitch, and blamed for defeat if he didn’t go. There was never any doubt that the home of the string bikini and the banana thong was going to win. In order to justify the gargantuan cost of the modern games, the International Olympic Committee long ago turned this into an emerging market development program. The great news for investors is that corresponding emerging stock markets have a history of tenfold returns going into the games. Look at South Korea and China. Only the 2004 Athens games were a bust, the home of the Olympics building a games that were far more than it could afford. I have long been a fan of the country that is doing everything right, with a perfect demographic pyramid and a liberal pro business government fueled by resource and energy exports. I managed to catch a 270% leap for my subscribers in the ETF (EWZ) this year. I wouldn’t’ rush out tomorrow and buy on the news, as an impending global stock market selloff is likely to pull it down with everything else. But it definitely should be at the top of your “buy on dips” list.

Oct 04 05:37 AM