Why the Brazil PMI confirms a downward spiral (Part 5)

Sr Emerging Markets Analyst

Continued from Part 4

The latest PMI placed Brazil under the 50 point line, signaling contraction

Out of the five key sub-indices making up Brazil’s (EWZ) PMI, five posted drops.

Implications for investors

Many investors stuck to their Brazilian holdings for two main reasons: a growth bounce triggered by the upcoming 2014 World Cup and expectations of government intervention. The problem with these reasons is that financial stimulus is less likely if inflation continues pushing upwards. Plus, a stimulus package would likely further depreciate the Brazilian real and further increase the costs for producers.

Credit in the country has been diminished, as banks have increased the amount of reserves to adapt to new standards. In the case of international banks, this refers to Basel III requirements. A stimulus package may simply go into the banks’ reserves and fail to multiply in the economy.

The only rational expectation to keep faith in the Brazilian (EWZ) market would be a targeted and successful stimulus package. But given the limitations we’ve discussed, the effectiveness of such a package may be doubtful and its effect on the market may be limited to the short term.

(Read more: How investing in emerging markets differs from developed markets)

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