At the trading desks in Sao Paolo, Brazil, you can hear a
collective sigh of relief.
The country's Bovespa market index, which had fallen roughly
30% over the two years ended March 1, has finally reversed
Since early March, this index has rallied more than 10% to
above 51,000, boosting the prospects of a range of long-suffering
exchange-traded funds (ETFs).
#-ad_banner-#Before you can conclude that you've missed out on
this impressive mini-rally, know that these funds remain far
below their multi-year averages. That last ETF, for example, the
ProShares Ultra MSCI Brazil ETF (NYSE:
, has rebounded from $32 to $48, but stood above $140 back in
2011. Most of these ETFs trade for less than half of what they
traded for back then (though some were launched since then).
The real questions are: What's driving this rebound, and what
does it mean for Brazilian stocks for the rest of the year and
The End Of Rate Hikes
Brazil's economy has been throttled by rising interest rates as
the government works to halt the advance of inflation, which
recently reached 6%. But the cycle of higher rates may be nearing
an end. The current benchmark 11% interest rate may move a tick
higher at the next meeting of the Brazilian central bank,
but that should mark the end of the rate
Brazil's woes over the past few years can also be attributed
to high levels of consumer debt that have curtailed spending.
More recently, a widespread drought is hurting crop yields and
may lead to power blackouts as hydroelectric-power systems lack
Even with the expected boost from the upcoming World Cup
games, Brazil's economy is expected to grow less than 2% this
year, a far cry from 2010, when GDP growth exceeded 7%. Against
such a bleak backdrop, the recent rally is surely curious. Yet a
pair of explanations help clarify matters.
First, there had been concerns that China's economy would
slow, cutting demand for Brazilian exports. The Chinese
government has recently signaled a willingness to provide fresh
economic stimulus, helping many commodities and emerging markets
Second, even with many headwinds, the Brazilian economy has
some clear positives. Unemployment remains near the lowest levels
seen in the modern era, and thanks to certain government actions,
wages have risen sharply. As a result, Brazilian consumer
spending is expected to start to rebound in coming quarters,
especially as interest rates aren't expected to move much above
Perhaps the simplest explanation for this rally is that
Brazilian stocks are very inexpensive,
as is the case with many emerging markets
Let's take at the
Market Vectors Brazil Small-Cap ETF (NYSE:
as an example. According to Morningstar, the portfolio's typical
holding is valued at 1.1 times book value, 0.64 times trailing
sales and 6.4 times cash flow. While U.S. stocks trade for a
similar 7 times trailing cash flow, they also sport price-to-book
and price-to-sales multiples that are more than twice as high as
this Brazilian fund.
That valuation disconnect makes sense. After all, over the
past two years, the S&P 500 has risen 40% while this
Brazilian ETF has fallen by a similar amount.
If the backdrop of full employment and rising wages leads you
to expct a rebound in consumer spending, then this is the perfect
ETF: 37% of the portfolio is invested in consumer discretionary
and defensive stocks, while another 18% is invested in real
Speaking of that sector, Brazilian homebuilder
remains a favorite way to play the Brazilian consumer class. I
profiled this company roughly six weeks ago on our sister site,
, and though shares have risen 30% since then, they still have
more than 50% upside to my $5.25 price target.
Risks to Consider:
The biggest risk for Brazil -- or any other emerging market
-- remains China. Rightly or wrong, investors believe that a
further slowdown in China would deal a tough blow to export-led
economies such as Brazil. So be prepared for fresh dips in any of
these investments if China wobbles.
Action to Take -->
To an extent, a focus on the rebound prospects for Brazil in 2014
obscures a broader point. Despite serious near-term economic
headwinds, Brazil is blessed with vast natural resources, an
increasingly well-educated workforce, and a massive export
opportunity into the rest of Latin America and elsewhere. This is
a country built for the next decade or two, not the next year or
two. The fact that shares prices remain multi-year lows, despite
a recent mini-rebound, simply underscores the growth and value
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