The Sky’s Not Falling in Brazil

In an increasingly dangerous world, buying into Brazil is starting to look less and less like a nutty idea. The iShares MSCI Brazil Small-Cap ETF (EWZS) is up 14% for us since late May net of the recent 1%-plus distribution, and that may be selling short the recent improvements in the country’s political and economic outlook.

It was only three months ago that Brazil stocks dove 10% in a day after President Michel Temer was fingered for corruption in an explosive scandal featuring wiretap evidence.

That sounded to some like a death knell for the government’s economic reform agenda and for the economy’s chances of shaking off a steep two-year downturn. “Recession May Return With a Vengeance in Scandal-Hit Brazil,” was Bloomberg’s pithy summary of the bear case on June 1.

In fact, the economy has hung in there, on track for marginal growth this year ahead of a stronger recovery in 2018. The election of a pro-business president in October 2018, made more probable by the recent corruption conviction of former Socialist president Luiz Inacio Lula da Silva, could serve as a catalyst for the economy as well as Brazil stocks.

In the meantime, Brazil has been helped by the improved economic indicators of key trading partner China, which is showing renewed appetite for Brazilian commodities like iron ore. Inflation has been dropping, allowing Brazil’s central bank to aggressively slash interest rates. The iBovespa stock market index has just about recovered all of its losses from May and June.

There has been good news on the political front too. Brazil’s Senate passed the government’s labor law liberalization by a wide margin, showing that the reform agenda remains much more popular than the disgraced presidential incumbent.

Lula’s conviction and Temer’s indictment show that the courts remain willing and able to tackle graft at the top. And troubles in neighboring Venezuela are demonstrating to many Brazilians the downside of leftist economic populism. This is a promising backdrop.

Of course this is still Brazil, so the stock market remains at the mercy of political bombshells and subject to the whims of foreign investors. But there’s good reason to expect a longer reprieve, especially if the dollar’s decline extends, boosting dollar-denominated returns from emerging markets.

The EWZS has served us well to date and remains a good deal. I’ve also started to research specific Brazil income plays to recommend on the next dip.     


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