EWZ Is A Easy Goal For Investors In This Year
Summary
- My projection for EWZ has an estimated alpha of almost 18%.
- The market was overloaded with more news then it could process at one time, which why the stock has fallen far below my target price.
- I do not feel that EWZ is a good long-term investment but can make alpha for its investors in the short-term.
The decision to invest in emerging markets should never be a decision taken without a decent amount of research. When you invest in a foreign country, even via ETFs, you are subject to both market risk and foreign exchange risk. The worse thing is that most of the time, these two risks are correlated with each other.
I believe that EWZ and any other ETF that track the MSCI Brazil 25/50 index are undervalued and still offer investors some alpha in the short-term. I feel that this occurred because of the compounding effect of the coronavirus and political issues that occurred at the same time. Do not get me wrong. I am not saying that investing in Brazil as a long-term strategy is a good idea. I am saying that there is some short-term alpha available due to the market overreacting after being bombarded with bad news.
FX Rate:
The way that I forecast currency is a little untraditional. Still, it had served me well for almost eight years when I was responsible for hedging the USD for a Brazilian company. I use a mix of technical analysis and the purchasing power parity to estimate exchange rates.
According to the Big Max Index, the current fair value of the Brazilian Real is 3.51. I use this value and a multiple that I will explain it soon, to find my resistance point. Up until last week, this multiple has served me well for the past five years. Then a mix of coronavirus terrible news and an essential Brazilian minister leaving, plus the possibility of another going soon, broke through my resistance.
After the impeachment of President Dilma, I used the high of the BRL during the period and divided it by the fair value according to PPP. That multiple was 1.53x. Every time the Big Mac Index would update its information, I would update my resistance point. So I will show you two tables below. One I made at the beginning of the year and the other I updated yesterday.
| As of 07 Jan 2020 | IMPLIED FX RATE | As of 28 Apr 2020 | IMPLIED FX RATE | |
| Jan-20 | 3.5100 | Jan-20 | 3.5100 | |
| Resistance | 5.3546 | Resistance | 5.7135 | |
| Support 1 | 3.9894 | Support 1 | 5.0981 | |
| Support 2 | 3.7344 | Support 2 | 4.2537 | |
| Support 3 | 3.6428 | Support 3 | 3.9894 | |
| Multiple | 1.53X | Multiple | 1.63X |
Real will strengthen against the dollar this year, but I do not believe it will reach fair value for another couple of years.
Grinold-Kroner Model (Top-down Analysis):
Grinold-Kroner Model is a top-down model used to forecast equity market performance. Though the model is easy to understand, it is not easy to gather the data for it. Since I already have the MSCI Brazil 25/50 index information available, I used the Grinold-Kroner model to make forecasts for this Index.
| Grinold-Kroner Model (2020E) | |||||
| Div1 Yield | Inflation | Earning g% | +/- Shares | P/E CHG% | Total r% |
| 4.5% | 2.2% | -12.3% | -2.0% | 35.7% | 28.1% |
The first component is the dividend yield for the period to be forecasted. I calculated this data from the below table. I used the dividend data for EWZ found via Seeking Alpha.
Source: Seeking Alpha Dividend History for EWZ
The 2020 inflation estimate came from Brazil's Central Bank focus report. I used the MSCI report from Yardeni Research, Inc for earnings growth. An increase or decrease in shares outstanding is labeled "+/- Shares" in the table. Remember that an increase in shares outstanding is bad for the investor, and a decrease is good. This information is based upon the data that I use to calculate my MSCI Brazil 25/50 Index price multiples. The change in P/E is based on the idea that the Index will end the year with a P/E of 13X.
CONCLUSION AND ALPHA:
I calculated that EWZ will have an alpha of 18.86%. I used a market return that assumes the S&P 500 will return to its all-time high by the end of this year, which I feel is high but better to be safe than sorry. This also means that the Brazilian Real will reach 5.0981 by the end of the year.
| EWZ r% | RFR | S&P R | EWZ BETA | ALPHA |
| 40.15% | 0.63% | 15.60% | 1.38 | 18.86% |
My conclusion is that EWZ is undervalued due to a special situation where the market was overloaded with more news then it could process at one time. I have a target price for EWZ at $ 36.22.
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Analyst’s Disclosure: I am/we are long EWZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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