Smoking hot Brazil ETFs

By Jason Chow
Globe Investor Magazine Online,
May 9, 2008

Brazil’s stock market has been sizzling hot in past years. But is it too late for investors to join the carnival? Hardly, the experts say.

Take a glance at the charts and you’ll see a rally of massive proportions. The country’s benchmark Bovespa index has risen more than five times in value in the past five years for a total return of 430 per cent and has climbed 11 per cent since the beginning of this year.

Earlier this month, bond-rating agency Standard & Poor’s upgraded the country’s debt rating to investment grade, which has led many market observers to reconsider the Latin American giant. Brazilian stocks rallied 8 per cent on the day alone.

Click to enlarge Investors may be wary of a dramatic rally that has already passed. But many pundits agree that this rally still has legs.

“It’s almost a perfect storm where everything is operating on all cylinders,” says Tom Lydon, president of etftrends.com and an adviser who’s been recommending the region to clients for months now. “With all that momentum, it would take a lot to turn it around at this point. The trend is firmly in place.”

The easiest way to get in on the Brazilian rally: Buy the ETF that tracks the country’s largest stocks. Traded on the New York exchange, the iShares MSCI Brazil Fund (EWZ-NYSE) follows the fund’s namesake index. Another way to get Brazilian exposure, the iShares Latin America 40 Index (ILF-NYSE) has more than 60 per cent of its fund invested in Brazil.

On the Toronto Stock Exchange, investors can also buy the Claymore BRIC ETF (CBQ-TSC). With a 48 per cent return over the past year, it is the best performing ETF in Toronto over the last year. It currently has a 47 per cent weighting in Brazil, 41 per cent in China and 6 per cent each in India and Russia.

For the purest Brazilian play, Mr. Lydon recommends the iShare MSCI Brazil, or EWZ fund.

The top two holdings of the EWZ fund, which has risen 16 per cnet in value so far this year, are Petrobras, the country’s top oil company, and Vale, the world’s second-largest mining company. These two holdings alone make up almost 30 per cent of the fund and in all, stocks in the industrial materials sector comprise a third of the index while energy makes up almost 30 per cent. That’s a good thing, pundits say. Putting a bet on Brazil is putting a bet on the hottest commodities.

“They are in the sweet spot of the commodity boom,” says Carl Delfeld, president of chartwelletf.com, who also has been recommending the fund in his newsletters.

Mr. Delfeld says Brazil is the best of the emerging bunch. The country often gets lumped together with Russia, India and China – the so-called BRIC countries – because of their similar growth patterns in recent years but when compared the other three countries, Brazil is still relatively undervalued, says Mr. Delfeld.

He points out that Brazil’s stock market is currently trading at 16.7 price-to-earnings ratio, well below India’s 24.1 P/E ratio and China’s 20.4 ratio. He added that Brazil’s price-to-cash-flow ratio is currently 6.9, below the world average of 8.7 and far below India and China, which are trading at 16.4 and 12.2 respectively.

“Even after this huge runup, when compared to India/China, it’s not out of whack.” Also worth noting, he says, is that Brazil’s stocks have continued to rise while the other BRIC countries have seen their own market rallies melt down in the past 12 months.

Mr. Delfeld adds that while the economy has been clipping along at a reasonable growth rate, it hasn’t experienced the double-digit growth of India or China. Instead, the rise in Brazilian stocks is more what he calls a “balance sheet story.” Since current president Luiz Inacio Lula da Silva took power in 2002, the government has slashed debt while the economy has curbed inflation, strengthened its currency and increased its trade surplus.

“If you look at the country like a corporation, the balance sheet is strong,” he says. “And this is reflected in the investment upgrade by S&P.”

There may still be a bump in stocks based on that move alone. Geoffrey Denis, Latin American strategist at Citigroup, upped his forecast for the Bovespa index earlier in May. He now expects the index to finish the year at 74,000 (it’s currently is at about 69,000), which is 10 per cent more than he previously estimated. He said the upgrade will mean an increase capital inflows into Brazil, which in turn would mean rising stock prices.

What could bring this rally all down? A drop in commodity prices and a recession in the United States that ends up dragging down the rest of the world. But ETF watchers like Mr. Lydon say the upside far outweighs the risks and that investors shouldn’t fight this trend.

“Brazil is at the forefront of emerging markets and it’s not going to slow any time soon,” says Mr. Lydon. “I’m getting more and more clients calling me about it. It’s really caught fire.”

Special to the Globe and Mail
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