Brazil ETFs have been on a roller coaster ride since the start of the year. Though the first few months saw terrible performance, these products have been performing quite well since the end of March on optimism that the incumbent Dilma Rousseff won’t be elected again as President in the upcoming general election amid faltering economic growth.
In fact, every public opinion poll has shown languishing voter support for Rousseff. Presently, only 34% of the respondents intend to vote for Rousseff against 37% in May and 43.7% in February (read: 3 Brazil ETFs Surging This Year).
Dwindling growth, high levels of unemployment, above-target inflation and red tape are worsening Brazil’s economic performance and have made the present government at the center of it all quite unpopular.
Making things worse, inflation for May rose at a higher-than-expected rate of 0.46%. Brazil's consumer-price index, the IPCA, now stands at 6.37%, up from 6.3% in April and close to the central bank’s upper limit target of 6.5%.
The country’s central bank has already made a series of rate hikes since early 2013 to keep inflation in check (read: 3 European ETFs to Buy After ECB Action).
The Recent Action
However, breaking the trend, the Brazilian central bank has recently kept the benchmark Selic rate unchanged at 11%. This ends a year long cycle of interest rate hikes, wherein rates have climbed steadily from a historic low of 7.25% to the current level.
Though the pause in interest rates might not be plausible to some given the high levels of inflation, the central bank minutes said that the “pace of expansion for domestic activity will tend to be less intense this year, compared to 2013.”
Also, the minutes suggest that interest rates are expected to stay at the present level at least for the remaining part of the year. A section of analysts believe that the move is a deliberate one by the central bank ahead of the general elections, in order to avoid any potential conflict with the government and the business class regarding a rate hike.
The statement clearly indicates that Brazil is expected to grow less than the 2.3% GDP growth rate clocked in 2013. Indeed, the first quarter growth numbers clearly signal this decelerating trend.
Latin America’s largest market expanded at a modest pace of 0.2% during the first quarter as compared to 1.9% in the year-ago quarter. Slowing growth in Brazil’s largest trading partner- China, took part of the blame, though economic turmoil and currency devaluation in neighboring trading partner Argentina also led to the slump in GDP.
In fact, economists have recently lowered Brazil’s growth forecast for 2014. The country is now expected to grow at a rate of 1.62%, lower than the earlier projection of 1.69% as per a Reuters report.
If the economy continues to weaken, the consensus estimates for an interest rate hike in early 2015 will also be put into question. Some economists also believe that worsening economic activity might lead the markets to expect a rate cut instead of a hike.
Following the central bank’s recent decision to stall the rate hike cycle along with Rousseff’s declining popularity, the Brazilian ETFs have been on fire. Moreover, the FIFA World Cup frenzy has provided further boost to Brazilian ETFs though not ignoring the fact that several Brazilians have taken to the street to protest against the extravagance (read: Can FIFA World Cup Give Brazil ETFs a Kick?).
All the Brazilian ETFs have clocked gains in excess of 3.5% in the past one week. Brazil Mid Cap ETF (BRAZ) has been the top gainer rising 7.45% in the past one week, while Brazil Infrastructure Index Fund (BRXX) and Brazil Consumer ETF (BRAQ) have added roughly 7.3% each.
The most popular and actively traded Brazilian ETF, iShares MSCI Brazil Capped ETF (EWZ), has surged 6.8% in the past week, along with the Brazil Financials ETF (BRAF) which also added the same return (see all the Latin American Equity ETFs here).
Investors can certainly keep a close watch on the above mentioned ETFs to ride further gains if any in the short run. However, we currently have a “Strong Sell” or “Sell” rating on the above ETFs and believe this is just a short-term blip. Unless the country’s structural problems are addressed, the above mentioned ETFs also bear the risk of more downside ahead.
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