Back To Brazil

by: Glenn Rogers

Sometimes being the least ugly girl in an ugly girl contest can be a winning strategy. That's certainly been true for the U.S. market this year. Despite anemic growth, political uncertainty, massive debt overhang, etc., the S&P 500 has outperformed most of the emerging markets where the growth has been much better than here. This is particularly true of the so-called BRICs which have been stock market darlings for the last few years.

These countries are Brazil, Russia, India, and China and their economies have been showing solid growth. Brazil has expanded by over 3% but their stock market declined 17.3% this year. In Russia, where economic growth was over 5%, markets dropped 11.1%. And that's after a sharp rally in recent weeks. India has seen economic growth of almost 8% yet their index is down over 15%. As for China, its growth rate is over 9% but it has experienced a market slump of 11.6% this year.

The S&P, on the other hand, is up 0.5%. In fact, if you rank this key U.S. index against emerging markets this year, it places ahead of 20 countries and behind just one, Indonesia.

Investors have been spooked by the European debt crisis and the potential for slowing growth in the aforementioned countries and have sought the relative safety of U.S. equities and, more particularly, U.S. Treasuries. This has proven to be a good strategy but it's likely that going forward investors won't continue to overlook the superior growth opportunities that the BRIC countries offer.

Personally, I've started to shift funds into some of these countries. This can be done directly through the many ETFs that are available or indirectly by buying U.S. companies that have a great deal of exposure to these nations like McDonald's (NYSE:MCD), Starbucks (NASDAQ:SBUX), and Yum Brands (NYSE:YUM), which I have recommended in recent issues. Other possibilities are Joy Global (JOYG) and Caterpillar (NYSE:CAT), which derive significant revenues from these high-growth areas.

For this column I decided to focus on Brazil which will be heavily in focus over the next couple of years since they are hosting two of the largest world sporting events: the FIFA World Cup in 2014 and the Olympics in 2016. Both will be held in Rio de Janeiro.

Either of these events is a big deal on its own. Hosting both is both a huge coup and a tremendous opportunity from a business point of view. Both events will require a dramatic upgrade to the infrastructure within the country, which should spur a considerable amount of economic activity.

Beyond these major sporting events, Brazil has enjoyed rare political stability for number of years and that combined with sustained growth for the last decade has transformed the country into a blossoming economic powerhouse.

Brazil has a number of things going for it including scale, abundant natural resources, and a politically favourable world position. It has no significant enemies and a large world customer base, particularly China which is anxious to acquire lots of iron ore and oil, of which Brazil has plenty. (Sounds a lot like Canada doesn't it?) As a result, economists are predicting that Brazil's GDP growth should average about 4% over the next three years. That's slower than the growth rate in recent years but a lot better than what both the Europeans and the North Americans are looking at; in fact it's probably double what we might expect.

No story is complete without some caveats and it's true that Brazil has battled inflationary pressures for years, with the rate now running around 7%. This is causing their central bank to keep interest rates high, which could be a drag on growth going forward. Corporate taxes are likely the highest in any of the emerging markets, running over 35%, and there is still a strong socialist streak that runs through the country's leadership.

These leftist tendencies were brought to light again recently when the president of Brazil, Dilma Rousseff, forced the resignation of the extremely competent CEO of the huge and profitable iron ore company Vale (NYSE:VALE) because he would not push programs that the government was advocating. Prior to that, the country's crown jewel, Petrobras (NYSE:PBR), was subjected to political tinkering which caused the stock to underperform its peers for many months.

But these caveats aside, it is likely that over the next couple of years investors will see significant returns by having some exposure to Brazil. Political interference aside, both Vale and Petrobras are great companies and I think you could take a position in either or both now.

Another popular ADR is AmBev (ABV) which is the number one brewer of beer and distributor of soft drinks in the country. I also own shares of Banco Santander Brazil SA (NYSE:BSBR) which is currently trading 44% below its 52-week high but has a yield of 8.5% and a p/e ratio of less than eight. There are two other banks you could consider: Itua Unibanco (NYSE:ITUB) and Banco Bradesco (NYSE:BBD). Both are larger in Brazil than BSBR but all three tend to trade in unison so I tend to buy the least expensive issue with the highest yield.

Of course, most investors buy Brazil through various ETFs or mutual funds that focus on the area. The largest by far in terms of assets is the iShares MSCI Brazil Index Fund (NYSEARCA:EWZ). It has had a huge run this past month, rebounding by nearly 20%, but is still down about 18% year to date. This ETF holds many of the issues mentioned above but spreads out the risk that may be involved with any particular equity. Since this gives you the whole country in one neat package, it's the best choice for someone who wants to add some Brazilian exposure to a portfolio without being forced to decide between individual stocks. The closing price on Friday was US$61.76. It's my top pick for this month.

To sum up, there are many ways to get involved with what appears to be a bright future in Brazil and since their markets have lagged this year you are buying some of these assets at discounted prices. That's not going to last forever.

Disclosure: I am long VALE.