Emerging Markets, Funds / ETFs

Rousseff Promises Big Changes: Is This Good For Brazil ETFs?

By Zacks Equity Research

Brazilian President Dilma Rousseff.  Photo courtesy AFP/Getty Images

Brazilian President Dilma Rousseff. Photo courtesy AFP/Getty Images

Very few thought that Brazilians would finally vote for the seemingly unpopular president (in the eyes of the global investing world) offering Dilma Rousseff another presidential term. After all, Dilma’s first-term leadership took Brazil to the technical recession in the first half of this year. This technical recession surfaced for the first time since the global financial malaise in 2008–09. Notably, the Brazilian economy grew at 7.5% four years ago (read: Brazil ETFs in Focus on GDP Contraction: Any Hope for 2014?).

Brazilian equities have been on a roller-coaster ride since the start of the year. Though the first few months were extremely choppy, later on Brazilian equity markets became extremely responsive to each poll survey. Polls showing lesser chance of Dilma’s win in the October elections sparked off a rally in Brazilian stocks and vice versa.  Foreign investors are actually expecting a change in the Brazilian government.

However, proving everyone wrong, Dilma won the first round but had to face a runoff voting against Aécio Neves da Cunha after failing to secure enough votes to form a government. Aécio Neves da Cunha emerged as a dark horse to capture the second position. On October 5, Dilma received 41.59% of votes followed by 33.54% votes secured by Neves (an ex-state governor).

Though this kept the hopes alive for the Brazilian stocks, on October 26, the incumbent Dilma Rousseff secured a close victory (52% vote) against the contender Aecio Neves in the run-off vote that was the narrowest margin in more than 65 years. As a result, soon after Dilma’s victory, the largest Brazilian ETFiShares MSCI Brazil Index Fund (EWZ) shed about 5% on October 27.

Is a Turnaround Possible?  

Hopes are still alive though the road ahead is sure to be bumpy. Rousseff has commendably kept the jobless rate at low level even in a slowing economy as noted by Bloomberg. Sky-high inflation has always been Brazil’s problem, resulting in a series of rate hike since early 2013 (read: Can Brazil ETFs Rebound After the Hard-Fought Election?).

Yet another rate hike to 11.25% amid elections reinforced the Brazilian central bank’s effort to contain the stubborn inflation. Notably, consumer prices in Brazil were jumping at a rate of 6.75% annually, way above the bank’s target of 4.5% (albeit with a tolerance of two percentage points). Though the investing world greeted this bold step by pushing stocks up, investors should note that rate hikes will only slow down economic growth.

On November 3, a Bloomberg article shows that economists reduced the outlook on Brazil by slashing the growth estimate for this year from 0.27% to 0.24% causing a huge sell-off. Petrobras – the largest publicly traded Latin American oil company, dominating Brazil’s oil and gas sector – led the decline.

On the other hand, the Fed will prepare for a rate hike after eight years sometime next year which is likely to weigh on emerging market currencies as investors flock back to the U.S. This will worsen the Brazilian current account deficit which is presently undergoing a tough phase.

Another threat will come in the form of commodity weakness. In the wake of the rising greenback, we, along with several other analysts, believe that Brazilian commodities like coffee, soybean and corn will see sluggish trading.

If this was not enough, Forbes indicated that Brazil auto sales are expected to shrink 5.4% this year validating the persistent weakness in the Brazilian economy. Notably, auto sales are often regarded as the mark of well-being of an economy.

Though Rousseff has vowed to bring about “great changes” ahead, the job will not be easy especially given the various policy changes in the global economy. Thus, we suggest investors to closely monitor economic fundamentals in Brazil before taking any stance on the country’s stocks and equities. Stocks are likely to be volatile until some meaningful reforms come up.

ETF Impact

Small-cap equity ETFs like Brazil Small-Cap ETF (BRF) and iShares MSCI Brazil Small-Cap ETF (EWZSETF report) have lost about 9% and 8% respectively in the last one month. EGShares Brazil Infrastructure Fund (BRXXETF report) and EWZ have each shed about 10% during this period. The sell-off may be excessive in this space reflecting the effect of Dilma’s win. Still, investors having a high risk appetite and interested to play on Brazil ETFs should take a cautious approach.

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