BRF VanEck Brazil Small Cap ETF

After a dismal 2013 and a weak start to this year, Brazilian markets were one of the best performing emerging markets last week, and they even outperformed the U.S. market.  During the week-ended March 21, the Brazilian stock market index – Bovespa Index – gained an impressive 5% as compared to flat returns from the S&P 500 (read: 3 Emerging Market ETFs Off to a Great Start in 2014).
 
Also, the most popular and the largest Brazilian ETF– iShares MSCI Brazil Capped ETF (EWZ) – has gained around 5% in the past one week, while another product Brazil AlphaDEX Fund (FBZ) has surged 7.2% over the same period.
 
The impressive performance was fired by the optimism that the incumbent Dilma Rousseff won’t be elected again as President in the October 5 general election. Investors continued pouring in money in the country’s capital markets driving shares higher.
 
Why are Brazilians against Rousseff?
           
Owing to poor public services, rising transport costs, corrupt politicians, slower growth rates, inadequate health and education services, high inflation level and overspending worries on the World Cup and the 2016 Rio de Janeiro Olympics, the President has increasingly become unpopular among the masses. In fact, last summer, hundreds of thousands of Brazilians took to the streets to protest against a highly corrupt government.
 
Most of the Brazilians are strongly against the government spending huge amounts of money for hosting the FIFA World Cup. They believe that the amount could have been better utilized in solving the country’s many problems. The mass scale street outrage did not help matters and her image was tarnished even more  (read: Inside the Continued Brazil ETF Slump).
 
Recently, Standard & Poor’s downgraded Brazil’s sovereign debt rating to BBB-, the lowest investment grade rating, in the wake of deteriorating government accounts, mounting debt levels and a sluggish pace of growth. The South American nation, which in 2010 clocked 7.5% growth, saw its growth dwindle to a mere 2.3% in 2013.
 
What the Recent Poll Results Mean?
 
However, the past week’s rally slowed somewhat after the poll results published by Brazil’s top polling firm, Ibope, towards the end of the week indicated trends contrary to popular belief.
 
According to the poll, Rousseff is expected to be re-elected for a second term as well, with 43% of the respondents backing her as against 15% for Senator Aecio Neves of the main opposition party PSDB.
 
While the Ibope poll favored the current President, 64% of the Brazilian voters want the next president to change the way Brazil is being administered. Quite expectedly, 63% out of those desire this change to come from some other president (see all the Latin American Equity ETFs here).
 
Will the Rally Continue?
 
Though the polls suggest a second outright win for Rousseff, the hope of a defeat for this very unpopular president is what is currently holding the Brazilian stock markets up. Even popular research firms believe that the numbers are likely to change against Rousseff once the election campaign intensifies and the opposition party gains recognition. The campaign is expected to gain momentum after the World Cup ends in mid-July.
 
Apart from this, some of the recent steps taken by the government seem to be one of the reasons for the current strength. Brazil’s central bank has made a series of interest rate hikes since last year to contain inflation. From a historic low of 7.25%, the interest now stands at 10.75% in Brazil.
 
Bottom Line
 
Irrespective of who comes to power, the Brazilian administration has to take serious steps to plug its structural problems. Following the sovereign credit downgrade, the rating firm has cut the credit rating on 13 financial firms and has put another 27 companies on credit watch negative. 
 
Also, the present government’s interference in the private sector and economy is expected to negatively influence the country's risk profile. Moreover, the strengthening of the Brazilian real is expected to put pressure on trade balances, with the current account deficit hitting a record high last month.
 
Thus despite the current bullish picture, Brazil ETFs are expected to have a tough time ahead and the rally might lose steam if the fundamentals of the Brazilian economy don’t improve. All the Brazilian ETFs are currently trading in the red in the year-to-date time frame.
 
We currently have a “Strong Sell” or “Sell” rating on all the listed Brazilian ETFs, including EWZ, FBZ, Market Vectors Brazil Small-Cap ETF (BRF), Brazil Infrastructure Index Fund (BRXX) and Brazil Consumer ETF (BRAQ) (read: 3 Country ETFs Hitting 52 Week Highs).
 
Thus, long-term investors should wait for some more positive developments in the Brazilian economy before jumping into the current rally. However, brave-hearted short-term traders can use this rally to think about going short on Brazilian ETFs.
 
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GLBL-X BRZL CON (BRAQ): ETF Research Reports
 
MKT VEC-BRZL SC (BRF): ETF Research Reports
 
EMERG-GS BRAZIL (BRXX): ETF Research Reports
 
ISHARS-BRAZIL (EWZ): ETF Research Reports
 
FT-BRAZIL AD (FBZ): ETF Research Reports
 
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