An Emerging Market Opportunity for Your Portfolio

Includes: BKF, EPU, EWZ
by: The Wild Hog

After analyzing and recommending numerous defensive portfolio strategies using US stocks, I have decided to focus future efforts on emerging economies (since our own government can't seem to agree on a budget plan, therefore making US equities unappealing at the moment). This commentary will focus on Latin America, and in particular Brazil, using Morgan Stanley Capital Indices as reference points. After analyzing data downloaded from a Bloomberg terminal, it appears that the Brazil is undervalued severely compared with its peers.

(Click charts to expand)
As the chart above shows, Brazil's P/E is interestingly below that of Argentina, Chile, Columbia, Mexico, Peru, Latin America, and other Emerging Markets in general. This may be a solid entry point into the iShares MSCI Brazil Index ETF (NYSEARCA:EWZ), which is trading around $70 at the moment. The fund is currently sitting on the bottom of a recent range, so picking up a few shares will likely result in price appreciation in the short term.
The ETF recently paid a healthy $1.08 dividend. The chart below plots the dividend yield for each index. Brazil's Bovespa currently yields around 3.3%, marginally above other indices, except Argentina. The ETF that tracks this index will provide diversification as well as a current income stream to your portfolio. Now there are many arguments against taking a position in Brazilian equities. For one, 6.7% year-over-year inflation is weighing down disposable income on the largest country, in terms of population, in Latin America. The central bank has been raising the selic, Brazil's overnight lending rate, in order to combat rising inflation. This has created an influx of capital pushing the real (the domestic currency) higher. South America's largest economy also has one of the lowest unemployment rates, which suggests firms are experiencing increased demand for products and hiring appropriately. The chart below plots the 4 largest (by population) countries and their respective unemployment rates.
*The pink dotted line represents Brazil, the orange line is Mexico, the yellow line is Columbia, and the green line is Argentina.
Brazil is one of the largest economies in the world. Its dependence on other countries is waning, lead by strong domestic demand for goods and services. Brazil's relatively low debt to GDP ratio (around 14%) makes it an attractive investment. The risk of "black swan" events is relatively low. War, disease, or weather-related phenomena haven't presented themselves in some time, so this should help calm investor nerves.
With the earthquake in Japan, sovereign debt crisis in Europe, and turmoil in the Middle East pummeling their respective domestic markets, investors may have some reserve about investing abroad. But, diversification is an important part of every investor's portfolio. Putting your eggs in one basket is not an appropriate strategy to grow a nest egg. Searching for profitable investment opportunities can be a daunting task, however when a little gem like Brazil is trading at an attractive price, passing on such an opportunity can be quite irresponsible.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EWZ over the next 72 hours.

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