Central bankers played the heroes last week, providing much needed liquidity to financial markets. Equity markets soared. Now, their continued strength depends on eurozone finance ministers, who this Friday will choose between saving the euro currency through an ever-closer union or letting it fall apart.
We’ve watched European finances smoulder for ages. Finally, a team of six central banks, led by the U.S. Federal Reserve, took action, reducing the cost for banks – especially cash-strapped European ones – to borrow U.S. dollars.
In China, slowing economic growth convinced the central bank to take its foot off the monetary brake for the first time in three years by increasing the lending capacity of its commercial banks. China had raised rates and imposed stricter lending rules on banks in an effort to curb inflation and property speculation.
Brazil went even further, announcing a range of monetary and fiscal measures to reinvigorate economic growth that, in the latest quarter, sagged to just 0.3%. The central bank cuts its main reference rate to 11%, the third cut since August. It cut a tax on foreigners buying Brazilian stocks. It cut the cost of borrowing for consumer loans. And the government cut taxes on a selection of retail products including pasta and stoves – all good for domestic business.
The EU and China decisions together helped equity markets rally between 3 and 5%, not so much because Europe’s ills were cured or that China’s own formidable bad-loan tumor was excised. Instead, the decisions renewed the tentative hope that central banks can still act when necessary.
Brazilian equities were among the biggest winners, rallying more than 5% on the news, especially on China’s decision. The two nations are the closest trading partners. Total trade between Brazil and China has quadrupled in the last five years and is double the trade between Canada and China. A quarter of Brazil’s exports go to China and 15% of its imports come from there.
But this last year has been tough for Brazil, as Chinese demand for Brazilian steel, oil and other commodities has contracted. The iShares MSCI Brazil ETF (EWZ), an exchange-traded fund of the 83 largest Brazilian companies, fell 23% this year, making it one of the worst performing emerging market ETFs. China’s move to promote growth will help revive demand. China recently began rebuilding its iron ore supply, to Brazil’s benefit.
Other factors like valuation and dividend yield also favour Brazilian equities. EWZ is trading at about 9 times trailing earnings, one of the lowest for emerging markets and near the P/E level of March 2009, just before it took off. Its dividend yield is an incredible 6.1%, partly reflecting the much higher local interest rates.
Unlike the Euro-PIIGS who are mired in debt, Brazil is running budget surpluses of about 3% of GDP. Its generally “prudent macroeconomic policies” led to upgrades in its sovereign debt rating by three agencies, the most recent being S&P (The same S&P that was vilified for its downgrade of the United States). Bond markets consider Brazil a better bet than Italy and Spain to say nothing of P, I and G.
A weaker currency will also help growth. Exporters complained for much of this year when the high interest rates pushed the real from about 55 U.S. cents to 65 cents. But the eurozone crisis and that tax on foreign investors quickly brought the real back to its comfort zone.
The real could strengthen again, especially since the central bank is encouraging foreign investment. But this will be offset by the further rate cuts. Markets are expecting the bank to cut the reference rate to about 9.25% by mid-2012.
Lower rates could also see investors shift from Brazilian debt to equities. Brazil’s debt market is three times larger than its equity market by total issuance. Hardly surprising: when top-tier Brazilian corporate bonds pay 11.5% in coupons, who wants their stock? Lower rates would shift this balance.
Of course, the eurozone decision still looms and Brazil is not immune. Will the finance ministers put national ego aside and agree to more integrated monetary and fiscal policies for the zone, in hindsight, something they should have done when the euro was born? The health of the world economy depends on it.
Chart courtesy of Bloomberg L.P.
|archerETF Metrix||02 Dec 2011|
|Ticker/Exchange||EWZ / NYSE|
|Name||ISHARES MSCI BRAZIL|
|Categories||Equity / Brazil / Large-cap|
|52 Week High||80.23|
|52 Week Low||49.25|
|Avg Daily Volume||18.3 Million shares|
|Avg Daily Volume ($)||$ 1.1 Billion|
|Total ETF Assets||$ 10.0 Billion|
|Allocation to 10 Largest Holdings||59.74%|
|ETF Annual Fee||.61%|
|ETF Trading Currency||USD|
|ETF FX Exposure||Brazilian real|
|Correlation to S&P TSX Comp.||79.20%|
|Return to Risk Ratio||-0.41|
|Beta to S&P TSX Comp.||1.36|
|Use of Leverage||No|
|Use of Futures||No|
|6 month Return||-18.65%|
|1 Year Return||-19.36%|
|3 Year Return||29.52%|
|Dividend Yield (TTM)||6.02%|
Disclosure: I am long EWZ.