EWZ Not a True Indicator of Brazilian Economy

I'm not a big fan of the iShares MSCI Brazil Index ETF (EWZ) as a long-term investor. The fund is too heavily invested in commodities and government-owned companies like Petrobras (PBR). The fund also conceals the structural flaws of the Brazilian economy, which is a major issue because EWZ does not hedge its investments back to the U.S. dollar but to the Brazilian real and that's bad news for investors. EWZ's fate is tied to the Brazilian real and the overall performance of the Brazilian economy.

From a commodity standpoint the fund has done extremely well because EWZ has benefited from the current global commodities boom, but this has created a false sense of security around this fund in terms of the Brazilian economy. Brazil cannot sustain higher growth rates and a reversal in commodity prices would be very painful. Most importantly, it has happened before.

One thing to keep in mind is the fact that Brazil is the weaker of the BRIC nations, underperforming Russia, India, and China in real GDP growth rates, labor productivity, and fiscal efficiency. Moreover, the recent payment surpluses have been used to make debt payments, leaving very little for the saving and investment needed to expand the Brazilian manufacturing sector, which is anemic compared to the other BRICs.

But the primary reason why I'm not so optimistic about Brazil is because the Brazilian government has done very little to address the issues that put an end to the previous Brazilian economic miracle: corruption, poorly-educated labor force, archaic institutions, protectionism and trade barriers, and extreme poverty (30% of the population lives below the poverty line).

There is no excuse. Brazil should be able to modernize given its wealth in natural resources, but that won't be possible unless the country educates its labor force and invests in infrastructure.
According to a recent Goldman Sachs report, Brazil spends almost twice as much on education (4.1% of GDP a year) as China, yet "it ranks poorly in terms of the average number of years spent in school."

In short, expectations for Brazil are quite unrealistic when you consider the country's current economic reality.

Disclosures: none

Comments

[jamookey:]

"..when you consider their current economic condition."But they have yet to tap the new oil fields offshore,and most analyst say commodities will continue to go higher.It's pretty obvious someone is trying to make their short position pay off.Many of the things the author says may be true today,but the markets look forward,and the future for Brazil is bright.

2008 May 22 09:49 AM

[bluesmoke:]

Good article. Perhaps you are right. But if Brazil was smart enough to beef up its alternative fuel supply 10 years ago, has found yet another large oil deposit, has seen their credit rating improve, watched the Real and the stock market rise, and consequently raised the standard of living for its people, they are doing something right. I know this is old news, but to their credit they have shown the rest world how to think outside the box.

2008 May 22 09:52 AM

[BRICLayer:]

"The fund is too heavily invested in commodities and government-owned companies like Petrobras (PBR). " These are the apparently well chosen asset holdings of the ETF. This is like complaining that the goose that lays the golden eggs has funny feathers.

"The fund also conceals the structural flaws of the Brazilian economy, which is a major issue because EWZ does not hedge its investments back to the U.S. dollar" Assumes that hedging against the U.S. dollar is good. NOT. If you are in play in foreign markets, it makes no sense to put one foot over there and leave one at home. Either play or don't play. Both have good arguments but making a play that invests abroad but is based in US $'s is inherently self-cancelling.

The litany of Brazialian woes betrays a vaguely elitist attitude toward developing nations. On the good side, Brazil doesn't shoot dissidents as a matter of policy (China), attempt to move toward/revert to Communism (Russia), or have diversity to the point of dilution of any forward cultural movement (India - this takes more detail than there is space for here).

On the up side, he's just wrong about strategic government investment. Check the Brazilian biotech initiative as an example. They're also starting to move on defense industries (albeit slowly). They have a continent load of infrastructure to build and are rapidly aquiring the capital to do so - they've long had the desire. Also, check the life time chart. The fund is relatively expensive but I don't really care if the managers are earning their money by earning me mine...and they are. There's so much more but in my opinion the play is: EWZ is an excellent part of a medium risk portfolio. Shadow it with a stop loss that's consistent with your risk tolerance; Wash-rinse-repeat (i.e. move the stop loss upward with the price of the stock).

2008 May 22 10:46 AM

[CXC:]

This article is full of oppinions what are NOT supported by reason/facts:
<p> </p>
"The fund also conceals the structural flaws of the Brazilian economy, which is a major issue because EWZ does not hedge its investments back to the U.S. " -- This is a SO outdated US-centric view, contrary to the very idea of *investing in foreign market" !!!
<p> </p>
"EWZ's fate is tied to the Brazilian real and the overall performance of the Brazilian economy. " -- Isn't that EXACTLY what intesting in Brazil suppose to do - tie the investment with the Brasillan economy?
<p> </p>
"But the primary reason why I'm not so optimistic about Brazil is because the Brazilian government has done very little to address the issues that put an end to the previous Brazilian economic miracle: corruption, poorly-educated labor force, archaic institutions, protectionism and trade barriers, and extreme poverty (30% of the population lives below the poverty line). " -- Has the author EVER looked at other BRIC countries? You got be kidding !!!

2008 May 22 11:14 AM

[jimsep:]

I am puzzled as to why the author doesn't think EWZ represents the Brazilian economy. The rest of his article shows that it does

2008 May 22 11:43 AM

[Flyboy:]

I smell a author who just shorted EWZ after it's nice gains from it's recent upgrade!?

2008 May 22 12:00 PM

[OilFieldTra...:]

I visit Brazil often. In the last 2 years I have seen people go from buying a T-shirt for their birthdays to buying MP3 players. Is it as rich as America? Hell no. Is it growing fast. Yes. Their big problem is unemployment. I do not see an uneducated work force. I see college graduates without work. It is just like the United States in one major way. Politics can make or break there growth cycle. All we can do is wait and see. By the way... I own EWZ. I hope this article creates a pullback on the ETF because I want to buy more.

2008 May 22 12:01 PM

[Max Zeledon:]

US-centric view? This is amusing. I'm from Latin America and travel to the region all the time. I know what life is really like in Latin America for the average worker and the middle class--the people who make those economies work. In Brazil the middle class is not moving up like in India, Russia, and China. I'm not the one who opted to compare Brazil to other BRICs, but since that's the benchmark that's what I used and by all measures it lags behind. Look at the numbers and compare. Opinions? I'm not gonna do your homework, but the numbers don't look so good for Brazil. Look them up yourself--Goldman Sachs has a great report on Brazil and so does the World Bank and the IMF. There is a lot of hype on Wall Street and that's because they are making a killing from the commodities boom, but these things function via a boom/bust cycle which unlike in the U.S. where you get a mild recession in between these things truly paralyze emerging economies for years and even decades. Read the economic history of Brazil, please! We have history to show us how these booms end. My only point was that this is not sustainable in the long term. Not under the current social and economic conditions. I'm not recommending anybody to buy this ETF right now.

Yes they found oil in Brazil. Well, Venezuela is drowning in oil yet look at the hardships Venezuela is going through--high unemployment, inflation, food shortages, declining GDP and productivity. Why? The political and economic culture is erasing any gains from oil. Sure, Brazil is not run by Chavez, but do you think Lula doesn't have corruption?

The sarcastic remark about investing in foreign markets was not necessary because there are plenty of countries that are relatively safer alternatives simply because they are well-diversified and fiscally responsible. Chile! The ECH fund is less known and it is not as hyped up in the news because you don't have the massive speculation we have in Brazil, but it is a better selection in my view.

Oh, yes, China and India are very poor nations, but they also have a middle class larger than the U.S. population

2008 May 22 12:04 PM

[Max Zeledon:]

The government's Applied Economic Research Institute found the richest 10 percent of Brazilians control 75 percent of the country's wealth, according to an analysts of figures mostly from 2006.

www.iht.com/articles/a...

2008 May 22 12:20 PM

[CES:]

I bought 50 shares on 11/7/2007 @ 81.98/share. Today it's at 97.62. This is 6.88% in 6 months. Not setting the world on fire but I would suggest it will continue to rise even faster now that PBR and the other companies involved all look like winners.

That's my experience and I'm satisfied. Good luck on your decision to buy or sell.

2008 May 22 03:27 PM

[jude2007:]

This is an interesting article, yet I am unconvinced. I have owned this etf for 2 years in one account, and bought some last month. EWZ is a pretty good performer, both long term and short term. I have stop loss orders, since I have learned not to grow committed.

I understand that in the US the richest 10% own 90%. So go figure!

I will hang in because I have more confidence in the gov't of Brazil, than I do in China, but again with stop loss protection.

2008 May 22 04:16 PM

[VSD:]

I have owned EWZ since 2006. Last week, i got out. Brazil used to be the cheapest BRIC market and now it is the most expensive. Brazil was always a way to play China's appetite for commodites. China is slowing and the ramifications of the earthquake are still unknown.

2008 May 22 08:32 PM

[EZK:]

Concerning his comment, "Moreover, the recent payment surpluses have been used to make debt payments, leaving very little for the saving and investment needed to expand the Brazilian manufacturing sector."

Well, I consider it a VERY good thing when a government pays off its DEBT! What makes a strong currency? A debt free country! What is a sovereign nation? A debt free country. Which country can determine their own fate? A debt free country. Which country can invest furture surpluses? A debt free country.

Ever looked at how home prices in CA, FL, AZ, and NV are doing right now? They were pumped up by debt, not fundamentals.

I'll trade a barrel of oil for the equivalent in debt anyday.

2008 May 30 12:39 PM