Can Brazil ETFs Keep Up Their Amazing Run?

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Includes: BRF, DBBR, EWZ, EWZS
by: Zacks Funds

While the whole investing world is busy discussing the timing of the Fed rate hike and its impact on several asset classes, Brazilian stocks are moving in tandem with the impeachment trials against former president Dilma Rousseff, who is accused of financing government spending illegally.

In fact, Brazilian stocks and ETFs are on a tear this year. iShares MSCI Brazil Capped ETF (NYSEARCA:EWZ) has added over 64% this year (as of August 29, 2016) and gained about 3% on August 29 despite strengthening Fed rate hike bets.

Though factors like a subdued greenback, the subsequent commodity strength and a world-class event like Rio Olympics 2016 also favored the rally, an expected change in government that can shore up Brazil's recession-stricken economy primarily backed this stellar run.

Can the Rally Last?

As the chances of an imminent Fed rate hike increased, "Brazil's real rose the most among emerging-market currencies" and its equity benchmark also added gains on speculation that Rousseff would be pushed out of the office permanently this week.

If Rousseff is impeached, the stand-in president Michel Temer will be able to freely enact pro-growth measures. As a matter of fact, in the recent past, any news against Rousseff turned out to be favorable for the Brazilian stocks as her administration was infamous for excessive red tape in the private sector.

If Rousseff is banned, there are chances of a short-term rebound in Brazilian stocks and ETFs, but in the long run things may not be very attractive.

Apart from the Rousseff issue, there are a few economic events, which can drive Brazilian ETFs ahead:

Is Recession Bottoming Out?

Investors should note that economic woes are not new to the Brazilian economy with its gross domestic product shrinking for the fifth successive quarter. Brazil recorded a 5.4% year-over-year decline in GDP in the first quarter of 2016. This week, the Brazilian economy is expected to come up with Q2 GDP data, which is estimated to be down 3.9% year-over-year. The narrower decline in expected GDP may be viewed as a positive.

Chances of Rate Cuts and Improving Growth

The economy is guilty of high inflation and unemployment. The Brazilian central bank is likely to hold the rates same at 14.25% in the upcoming meeting due to sky-high inflation.

Consumer prices in Brazil rose 8.74% year-over-year in July 2016, slowing from an 8.84% rise in June but above market expectations of 8.66% and way higher the central bank's goal of 4.5%. On a positive note, the reading was the lowest since May last year.

Probably sensing this positive trend, an economists' survey indicated that the central bank may cut its key rate to 11.25% in 2017, from the present 10-year high of 14.25%, going by an article published in Bloomberg.

The latest survey also indicates that GDP is expected to grow by 1.23% in 2017 - up from 1.20% and 1.10% in the earlier two surveys. However, inflation will likely be 5.14%, slightly higher than 5.12% forecast earlier, as per Bloomberg.

Threats Remain…

Everything depends on Rousseff's expected overthrow and Temer's ability to implement proactive changes. Otherwise, Brazilian stocks are overvalued at the current level after such an astounding run this year.

If the Fed tightens policies sooner than expected, the greenback will gain strength and commodities will likely fail, putting this commodity-rich economy in danger. Coming to the corporate health of Brazil, S&P Global Ratings now holds a negative outlook over 60% of Brazil's corporate borrowers, as per Bloomberg.

ETFs in Focus

EWZ, iShares MSCI Brazil Small-Cap ETF (NYSEARCA:EWZS) and VanEck Vectors Brazil Small-Cap ETF (NYSEARCA:BRF) have a positive weighted alpha of 52, 62.80, and 63.20, respectively. A positive weighted alpha hints at more gains. Investors should also note that EWZS and BRF added about 2.7% and 2.9%, respectively, on August 29.

Investors also have a tool to mitigate the impact of a rising U.S. dollar for Brazil investing, namely Deutsche X-trackers MSCI Brazil Hedged Equity ETF (NYSEARCA:DBBR). This fund has a positive weighted alpha of 21.40.

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