For the last few years, Charles de Gaulle’s quip that “Brazil is the country of the future, and always will be,” seemed like an anachronism as the Latin American economy seemed to blossom. But it didn’t last long.
Unfortunately for Brazilians, de Gaulle’s witticism now seems on target once again. And things may deteriorate even further before they get better. For investors, that will likely mean staying away from Brazilian stocks until the second half of next year.
How bad is it? Pretty awful. Brazil is beset by an economic crisis and a huge political controversy that is threatening its president.
Let’s start with the economic issues. The economy is highly geared toward the commodity sector, so when the prices of everything from oil to iron ore and foodstuffs fell over the past year or so, Brazil felt the pain more than some other countries.
That caused the economy to sharply contract, says Michelle Campbell, senior economist for Latin American at Dun & Bradstreet in London. She sees a decline in GDP of up to 3 percent this year and a further 1 percent drop next year.
On top of that, the country has an inflation problem. Brazil’s central bank, Banco Central do Brasil, reports inflation this year at 9.5 percent versus a target inflation rate of 4.5 percent.
“The inflation complicates the monetary policy options,” says Campbell, because the central bank cannot lower interest rates to stimulate the economy, because it might send inflation even higher.
The slumping economy is also crimping government revenues, leading to what was once a projected surplus for 2015 now looking more like a deficit. “The fiscal side remains the largest macroeconomic issue for Brazil at the moment, and there is no improvement in sight,” New York bank Brown Brothers Harriman said in a recent report.
The fallout from the fiscal worries was a cut in the country’s debt rating to noninvestment grade by Standard & Poor’s. To top it off, the value of the Brazilian real has plummeted, down around 40 percent versus the dollar over the last year.
To get things going again, Brazil needs to introduce economic reforms, says Jeremy Lawson, chief economist at Standard Life Investments in Edinburgh, Scotland. He points to rigidities in the labor market, whereby inflation becomes self-fulfilling.
Can the country of the future be saved? It’s tricky, because there is a massive corruption probe involving Petroleo Brasileiro S.A. Petrobas (ticker: PBR), which is embroiling politicians and has led for some to call for the impeachment of President Dilma Rousseff.
“There is no clean skin with a great reputation waiting to take over,” Lawson says. “Public confidence is quite low.” In other words, the voters are very unhappy and there is no obvious white knight waiting to rescue the situation.
So what is an investor to do? Avoid stocks in the energy sector or the construction sector, says Don Coxe of Chicago-based Coxe Advisors. He worries that both areas in the economy may get sucked into the corruption scandal.
Instead, Coxe suggests that investors who want to buy into Brazil focus on stocks with exports, because companies that export aren’t reliant on increasingly weak domestic demand. They’ll also benefit from the dramatic decline in the value of the real, as products will be cheaper to foreign buyers.
For Brazil, when you exclude the beleaguered commodities sector, that means the industrial sector that manufactures automobiles and auto parts may be an investor’s best bet.
But Lawson says it may be better to wait for a while before putting money to work in Brazil because the economy is weak and won’t support good growth in business investments, at least for now. “From a fundamental perspective it’s not a place to be overweight,” he says.
Three things need to happen to make Brazil more enticing to investors, Lawson says. Inflation needs to start falling, or at least show a top; the political turmoil needs to end; and lingering questions about Brazil’s creditworthiness need to be dispelled so investors don’t have to worry about a potential default.
Investors can consider Brazil as early as the second half of 2016, Lawson says. “Economies aren’t in recession forever and market don’t go down forever.”
Two ETFs to buy for Brazil stocks. For investors who don’t want to pick individual stocks, it might be worth looking at some exchange-traded funds. Two to consider are the Market Vectors Brazil Small-Cap ETF (BRF), which holds 65 stocks — the top holdings being Brazilian holding company Sul America, the agricultural holding company Adecoagro (AGRO), and the dental care company Odontoprev. The fund has returned a 12-month yield of 7.6 percent, and has a reasonable expense ratio of 0.60 percent, or $60 annually for every $10,000 invested.
Alternatively, there is the iShares MSCI Brazil Capped ETF (EWZ) that roughly tracks large- and mid-sized companies in the Brazilian stock exchange, the BM&F Bovespa. It currently holds 65 stocks, with its top holding being Ambev (ABEV), the Brazilian beer distributor. Potential investors should note that five of the fund’s top holdings make up 35 percent of the EWZ, and that it boasts a 12-month yield of 4.5 percent with expenses of .62 percent.
As always, consult your financial advisor before investing.
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Why Investing in Brazil Will Remain Difficult originally appeared on usnews.com
