Source: Diego Torres Silvestre via
When it comes to overseas investment opportunities, few
countries seem to attract investors as strongly as Brazil.
The Brazilian economy offers investors a nice blend of natural
resources that supply businesses with much-needed cash flow, while
an ongoing infrastructure build-out around Brazil's major cities
continues to fuel Brazil's GDP expansion. It's the seventh-largest
economy in the world, yet it has decades of infrastructure
improvements to make, which could make it the perfect investment
However, for investors who aren't too familiar with the
Brazilian economy or don't have the time to filter through annual
reports from the nation's top companies, discovering the best way
to invest in Brazil may not be easy. This is why so many investors
have turned to the
iShares MSCI Brazil Index ETF
throughout the years.
As we examined last week, there are
quite a few reasons
to believe this ETF could head even higher, including accommodative
domestic policy from Brazil's government, the aforementioned blend
of growth and stability, and Brazil's abundant natural
Could this fund head lower?
Yet there's another take on this ETF -- one that could see the
iShares MSCI Brazil Index ETF head markedly lower. Today, we'll
take a closer look at three specific headwinds that could stand in
the way of optimists and the prospect of long-term stock gains.
Of course, before we dive into our analysis, I'd be remiss if I
didn't remind investors that the stock market is a two-way street,
and it's the collective opinions and trades of millions of
investors around the globe that send stocks up or down. In other
words, just because you're reading a bearish thesis on the iShares
MSCI Brazil Index ETF doesn't mean that it will necessarily
I'd also be doing you a disservice if I didn't briefly describe
what investors are buying into when they invest in this Brazilian
fund. The purpose of the fund is to provide investors with
investment exposure solely to Brazil. It covers about 85% of the
Brazilian stock market through various mid-cap and large-cap
stocks, per iShares' prospectus. As you can see below, of the 74
holdings currently in the fund's portfolio, financial stocks hog
the allocation of the nearly $5.3 billion in assets under
management, and its expense ratio of 0.61% is actually lower than
that of many peers.
Now that you have a better understanding of the fund itself,
let's look at why it could be headed lower.
Inflation is a big concern
that has the potential to push the iShares MSCI Brazil Index lower
is persistently high levels of inflation.
Inflation is a tricky problem for countries to tackle because
they need the prices of goods and services to rise modestly in
order to put extra wealth in the hands of businesses. A
deflationary environment might be welcomed by shoppers for a short
period, but it usually leads to the oversupply of goods and
services as businesses try to make up for falling prices and
reduced profits. If that happens, companies may have trouble
expanding their businesses and hiring.
However, too much inflation can be just as bad. This is the
current problem in Brazil, where the annual inflation rate is 6.52%
as of June, up from 6.37% in May. Inflation rates in Brazil have
remained above 4% for nearly seven straight years because
production is not stepping up to meet the demand ofa burgeoning
middle class that suddenly has the wealth to buy goods and
The easy solution to inflation is to raise lending rates in
order to cool lending -- and thereby spending -- and allow supply
to catch up with demand. The problem with that is that Brazil
already sports a high interest rate of 11%, which is up from just
7.25% about a year and a half ago. If Brazil gets too aggressive
with its rate hikes, it could send the economy tumbling into a
Long story short, the Brazilian central bank's response to
inflation will signal what Brazil's economy may do next. Given that
inflation is remaining stubbornly high despite aggressive recent
interest rate hikes, I'd suggest that bank lending capacity and
consumer buying power could take a substantial hit sooner rather
Commodity prices remain weak
Another big concern for those investing in Brazil is that the
country's ties to its natural resources can also be a hindrance if
commodity prices and/or demand don't cooperate.
Brazil's vast reserves of copper, platinum, coal, and iron ore
are great when the global economy is firing on all cylinders, but a
steep drop in a number of natural resources can mean less cash flow
generation and the potential for Brazil's mining industry to drag
down GDP growth prospects.
Iron ore operations. Source: Peter Craven via
Iron ore prices, for instance, have fallen to about $96 per dry
metric ton in July 2014, a level that hasn't been seen since
September 2009, during the height of the Great Recession.
Similarly, platinum, after bottoming at less than $800/oz.
following the recession and rebounding to more than $1,900/oz. in
2011, has once again found itself in a downtrend and is valued at a
little over $1,400/oz.
Though traders have certainly played their part in pushing
commodity prices lower, China, the world's largest buyer of a
number of natural resources, has been demanding less as it grapples
with its own slowing growth. With one of Brazil's largest buyers
suddenly not buying as much, and many commodity prices stymied, it
would appear that many of Brazil's natural resource industries are
A possible housing bubble
Lastly, investors should keep a close eye on Brazil's housing
market, which has seen a rapid appreciation in prices over the past
six years. According to the FIPE-ZAP Index, which measures home
property values, Rio de Janeiro and Sao Paolo have seen home prices
skyrocket by more than 250% and 200%, respectively, since 2008.
View of Sao Paolo, Brazil. Source: Rodrigo Soldon via
On one hand, this move makes some sense. We've seen a
corresponding increase in Brazil's inflation over this time as its
middle class's wealth has grown. In other words, it would imply
that at least some of this increase is due to an imbalance in
demand. There aren't enough homes on the market to meet citizens'
demand to buy them, so prices are going up in response.
However, we in the United States are also uniquely familiar with
the idea of not relying on real estate as an investment because we
recall what happened when the U.S. housing bubble burst. It's quite
possible that rising lending rates could stymie future
housing-sector growth prospects in major cities like Rio de Janeiro
and Sao Paolo. If that were to happen, and mortgage loans and real
estate investments dried up, Brazil's economy would certainly take
Tying things together
Brazil is a large and diverse economy that has, for years,
offered investors above-average growth potential due to its
abundant natural resources and its free-spending government.
However, macroeconomic factors like inflation, commodity weakness,
and the potential for a housing bubble all loom over the iShares
MSCI Brazil ETF as possible reasons why it could head sharply
lower. Regardless of where you stand as an investor with regard to
this ETF, you need to closely examine both sides of the coin before
making your decision to invest in this Brazil-focused ETF.
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3 Reasons iShares MSCI Brazil Index ETF (
) Shares Could Fall
originally appeared on Fool.com.
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