Value Hunting: Brazil Vs. Mexico

June 25, 2018

It’s time to take another look at Brazil ETFs. Brazil equities are currently oversold.

That’s the view of not one, but four different market experts speaking last week about emerging market investing—specifically, Latin and South America investing—in a BlackRock-hosted discussion in New York City.

Among the pundits: BlackRock’s head of ETFs, Martin Small, as well as the firm’s Chief Investment Strategist for LatAm and Iberia, Axel Christensen. Also in the talk, Patrick Jamin, CIO at NorthCoast Asset Management; and Tina Byles Williams, CEO and CIO at FIS Group, which manages $7.5 billion in equity investments globally.

Value Play

So, what’s the story on Brazil? For starters, it’s one of value.

Brazil has faced significant challenges in recent months. From political turmoil centered on corruption scandals and the upcoming presidential election, to a massive national trucker strike that paralyzed the flow of goods throughout the country for days. In addition, the local currency has now devalued about 12% this year—all of which have pounded equities.

Year-to-date, the three largest Brazil large- and small-cap equity ETFs (nonleveraged or inverse) have taken a beating, dropping some 20%:

 

 

Bad News Baked In

Prices are low, but the outlook going forward isn’t that grim, and a lot of these bad “news” has already been priced into the market, NorthCoast’s Jamin says.

“We look at valuations, the macroeconomy and technical indicators. We look at GDP, NAFTA, interest rates—all of these factors in the background,” Jamin added. “We look at sentiment indicators, like manufacturing PMI, which signals intentions of manufacturing. And we look at how hedge funds are positioning themselves as they hear this news.”

“We rank countries with all these indicators, and the ranking says Brazil is oversold,” he noted.

The current price-to-earnings of the index underlying EWZ is 15.4, Jamin says—a relatively attractive level at a time when there’s acceleration in GDP recovery, the earnings stream is improving and inflation is within targets.

China Factor

Another factor that’s potentially supportive for Brazil is the ongoing trade dispute between the U.S. and China. If the trade relationship between these two countries sours, Brazil could pick up some trade business—it’s the largest supplier of soybeans, for instance.

“Mexico is very linked to the U.S., but the rest of LatAm is more linked to China,” FIS Group’s Williams said. “Brazil is in a position to benefit from a China/U.S. trade spat, whereas Mexico is a clear casualty.”

And that brings up another interesting point: the relative attractiveness of a market.

Comparison Shopping: Brazil Vs. Mexico

When it comes to emerging market investing, the region is diverse, presenting economic and political issues that are unique to each country. These are massive economies, often facing similar issues to those of the developed world, meaning U.S. investors can be selective in the region, evaluating opportunities on a relative basis.

In this context, Brazil looks promising relative to the other large player in the Latin America region: Mexico.

Mexico Outperforming, Though

Earnings in Mexico are headed lower; there is uncertainty on trade centered on China and NAFTA; and there is an upcoming election that many see as negative for inflation. Even the country’s PMI—that sentiment metric on manufacturing intentions—is at 51, the lowest level since October, according to the panel.

All of this is leading to one unanimous conclusion: Investors are positive on Brazil, bearish on Mexico—at least everyone on BlackRock’s panel agreed on that, even though at face value, the largest Mexico ETF, the $1 billion iShares MSCI Mexico ETF (EWW), is doing better this year than Brazil’s EWZ.

 

Charts courtesy of StockCharts.com

 

“There’s uncertainty due to the election in Brazil and Mexico, but relative to Mexico, inflation in Brazil is within target; not so much for Mexico,” Williams said. “And given the likely political outcome in Mexico, I don’t see inflation abated.”

“For a U.S. investor, currency is important, and both currencies have depreciated considerably, but the peso has a lot more to fall than the real due to more favorable inflation,” she added. “There are pockets in Brazil that are a clear opportunity, like small-caps, but it’s a relative comment. It’s not a roaring opportunity, but Brazil is oversold.”

Contact Cinthia Murphy at [email protected]

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