BRICs Start Building A Rally

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Includes: BIK, BKF, EEB, EMDD
by: Motif Investing

Summary

Brazil has led emerging market stocks higher; the country's stock market is up 19 percent this year.

The country's political scandal has brought hope of a leadership change.

The Fed's slower interest rate pace has helped dollar-based emerging market funds.

If you're looking for the year's best-performing stock market this year, look no further than Brazil, where the Bovespa stock index is up 19 percent, making the S&P 500's 3.8 percent rise positively yawn-inspiring by comparison.

When a country's stock market has just posted its best monthly increase in 17 years amid its worst recession in 25 years, it's time to take things seriously.

Who knew it would take surging sentiment for the ouster of a sitting president?

The outperformance by Brazilian equities is in stark contrast to how the country's government and economy are faring, but investors appear to be betting that an impeachment of President Dilma Rousseff will change the economic outlook for the country.

The rise in Brazilian stocks has contributed to the recent outperformance of the BRICs Building motif, which has a 15.1 percent weighting in Brazilian stocks, and has gained 8.2 percent in the past month. The motif's Brazil segment did even better, rising 23.3 percent in the last month.

Over the past 12 months, the motif has underperformed, falling 11.9 percent. In that same period, the S&P 500 was up 0.3%. Meanwhile, Brazil's real, last year's worst-performing currency, is up nearly 10 percent this year.1

Political Crisis Gripping Latin America's Largest Economy

The trouble started two years ago, when prosecutors discovered a scheme inside Brazilian oil giant Petrobras (NYSE:PBR), where contractors were accused of paying nearly $3 billion in bribes to executives who ultimately funneled money into the campaigns of parties in Brazil's governing coalition.2

Both politicians and private citizens have been jailed since, with the list of suspected offenders expected to grow.

Unfortunately for longer-term investors in Brazilian stocks, the scandal hit as the country whose economy relies heavily on commodities exports also faced a rash of economic challenges. Falling commodities prices have sent unemployment soaring to 9.5 percent from 6.8 percent just one year ago.3

Last week, the Brazilian Democratic Movement party, which played a key role in Rousseff's re-election, voted to break away from her government, with pundits expecting this would dramatically increase the odds of the president being impeached by the lower house by early May. This step would force Rousseff to step down temporarily.

While her departure is the optimal scenario investors seem to be responding to, some Brazil watchers caution that any political change would take some time.

"This impeachment process will not go as quickly or cleanly as markets seem to be pricing in," Win Thin, head of Emerging Market Currency Strategy at Brown Brothers Harriman, told CNBC.com.

However, emerging market investors haven't been merely relying on the resurgence of Brazil. The Financial Times recently reported that emerging market bond and equity funds have begun to attract small inflows, pulling in about $1 million a week for the first half of March, suggesting eight months of consecutive outflows may finally come to an end.4

Investors have pulled $48.7 billion from cross-border funds since flows turned negative last July, but the recent rebound in oil prices and positive developments from China have pushed investors back into emerging market stocks.5

Adam Laird, head of passive investments at fund supermarket Hargreaves Lansdown, told FT the fact that the the U.S. Federal Reserve scaled back forecasts of rate hikes was also good news given that rising interest rates are a specific threat to emerging market bonds, in view of the fact that many of them are issued in, or linked to, U.S. dollars.

Considering investors are relatively new to their bullishness toward emerging market stocks, the sector's rally may have additional upside.

  1. Seema Mody, "Political upheaval bullish for Brazilian stocks," cnbc.com, March 30, 2016 (accessed April 3, 2016)
  2. Simon Romero, "Insider's Account of How Graft Fed Brazil's Political Crisis," nytimes.com, April 3, 2016
  3. Simon Romero, "Insider's Account of How Graft Fed Brazil's Political Crisis," nytimes.com, April 3, 2016
  4. Aime Williams, "Emerging market funds show signs of recovery," ft.com, March 25, 2016
  5. Aime Williams, "Emerging market funds show signs of recovery," ft.com, March 25, 2016

International investments involve additional risks you should be aware of, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, news that can trigger volatile conditions, and the potential for illiquid markets.