Make a Quick Killing From Brazil’s Epic Folly

Brazil’s emergence as an economic powerhouse was often referred to as “The Samba Effect.” Brazilians these days are still dancing the samba, but on the edge of an abyss. Brazil is grappling with a multitude of dire woes that will only get worse in coming months.

On May 23, S&P threatened to downgrade Brazil deeper into junk territory by changing the country’s outlook to “CreditWatch negative.” Below, I highlight a simple trade to cash in on Brazil’s failure of leadership.

Don’t get me wrong: Latin America as a whole is once again a vibrant investment destination (see my April 4 article, “Latin American Stocks: Dancing to a Faster Beat”). According to the latest data from the Economic Commission for Latin America, the region will bounce back in 2017 from a dreary 2016, making certain Latin-based stocks good value plays now. Mexico, in particular, is enjoying robust growth. But Brazil is the weak link in the chain.

Humane investors don’t wish misfortune on an entire society, but if the country’s leaders are guilty of massive corruption and economic mismanagement… well, you might as well profit from their folly and the resulting financial imbalances.

Brazil’s decline: a crying shame…

For many years a growth super star, the BRIC nation of Brazil is crumbling, brick by brick. What the heck happened? This vast country was once touted as a leading emerging market opportunity. No longer.

Corruption in Brazil pervades all levels of society. Notably, the state-controlled oil and gas “super major” Petroleo Brasileiro SA Petrobras (NYSE: PBR) over the past two years has been the focal point of criminal wrongdoing on a mind-boggling scale.

During the oil price boom leading up to the crash in mid-2014, Petrobras was a juggernaut and its stock soared. The company took out huge debt to exploit deepwater drilling but the good times fueled corruption, as PBR sought favors from contractors and politicians of both parties by paying out kickbacks and bribes in the billions of dollars (yes, billions).

The long oil price recession laid bare many of Petrobras’ inherent weaknesses and inefficiencies, as well as exposing the illegal rot within. Oil prices today are rebounding, but the company remains deeply indebted and it’s still under scrutiny.

Brazil’s Supreme Court recently approved investigations into eight members of President Michel Temer’s cabinet, as well as 24 senators and 39 lower-house deputies, involving Petrobras-related graft. Temer had been able to sidestep these probes — until now.

On May 17, the influential Brazilian newspaper O Globo reported that Temer had been caught on tape endorsing the payment of hush money to a political crony convicted of taking bribes. As Homer Simpson would say: “D’oh!”

The very next day on May 18, the benchmark iShares MSCI Brazil Capped ETF (NYSE: EWZ) plummeted by 16.3%.

The secret recordings were made as part of a complex police investigation that continues to ensnare other high officials. The Temer Tapes are generating political turmoil in Brazil, which had already endured a series of scandals under Temer’s predecessor Dilma Rousseff, who was impeached and removed from office in August 2016.

Temer’s opponents are now calling for his removal, a prospect that has tanked the country’s financial markets. In the immediate wake of the damning news reports, the opposition filed a motion for his impeachment in Congress. The president’s approval rating has sunk to a dismal 20% and is sure to fall further.

Impeachment: a threat to vital reforms…

Brazilian markets fear that the scandal will undermine the economic reforms that Temer initiated after he took over as president from Rousseff. Temer has been trying to loosen the country’s inflexible labor laws, revamp the untenable pension system, and reduce the country’s unsustainable debt. Meanwhile, the Brazilian economy wallows in its worst-ever recession.

Brazil’s gross domestic product (GDP) shrank by 3.8% in 2015, the biggest contraction in a quarter century. GDP continued falling to register a year-over-year decline of 3.6% in 2016. The International Monetary Fund projects GDP growth in 2017 to stay flat at best. Inflation stands at 10.6%, with unemployment at 7.6% and rising.

Brazil also is a debt bomb waiting to explode. The country’s government debt-to-GDP averaged 56.99% from 2006 until 2016, when it reached an all time high of 69.49%.

Before oil prices started to recover in the second half of 2016, sputtering global growth and depressed commodity and energy prices clobbered Brazil’s mining and industrial sectors. Now that commodity and energy prices are rising again, the country should be on a path to recovery. But that’s in a perfect world. Problem is, much of the nation’s misery is self-inflicted, as the public sector remains bloated, inefficient and corrupt. Outraged and increasingly impoverished Brazilians regularly take to the streets in violent protest.

While Brazil teeters on the precipice, here’s an easy way to cash in:

Buy shares of the ProShares UltraShort MSCI Brazil Capped ETF (NYSE: BZQ), an inverse exchange-traded fund that seeks daily investment results that correspond to two times the inverse of the daily performance of the benchmark MSCI Brazil 25/50 Index. If the index falls, say, 3% on any given day, BZQ should rise by 6%.

With assets of $34.37 million, the fund’s expense ratio is a reasonable 0.95%. This ETF is the simplest available strategy to short Brazil’s overall economic mess. Keep in mind, leveraged ETFs such as BZQ aren’t designed for long holding periods, perhaps only a few weeks depending on your risk tolerance.

If you’re risk-averse, this fund may not be for you. But it allows you to make a quick profit on a train wreck that no one seems able to stop.

Do you have any comments or questions? Send me an email: — John Persinos

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